Understanding Negotiable Instruments for REG
Negotiable instruments are vital to business transactions and are a key component of the REG section of the CPA exam. This module will break down what constitutes a negotiable instrument, its key characteristics, and the implications for parties involved.
What is a Negotiable Instrument?
A negotiable instrument is a signed writing that contains an unconditional promise or order to pay a fixed amount of money, on demand or at a definite time, to order or to bearer. It serves as a substitute for cash and can be transferred from one person to another.
Types of Negotiable Instruments
| Instrument Type | Key Characteristic | Example |
|---|---|---|
| Draft (Order to Pay) | Drawer orders drawee to pay a payee. | Check |
| Note (Promise to Pay) | Maker promises to pay a payee. | Promissory Note |
The two primary categories of negotiable instruments are drafts and notes. A draft involves three parties: the drawer (who orders payment), the drawee (who is ordered to pay), and the payee (who receives payment). A check is a common example of a draft. A note, on the other hand, involves two parties: the maker (who promises to pay) and the payee (who receives payment). Promissory notes are a typical example.
The Concept of 'Order' vs. 'Bearer' Paper
The method of payment specified on the instrument is crucial for its negotiability and transferability. Instruments can be payable 'to order' or 'to bearer'.
Unconditional Promise or Order
The promise or order to pay must be unconditional. This means it cannot be subject to any external conditions or contingencies that would affect the obligation to pay.
A statement of the source of funds (e.g., 'payable out of the proceeds of the sale of widgets') or a reference to another contract does NOT make the promise conditional, as long as it doesn't require the instrument to be performed in accordance with the terms of that other contract.
Fixed Amount of Money
The instrument must specify a fixed amount of money. This amount must be ascertainable at the time of payment. It can include interest, but the principal amount must be clear.
- In writing, 2. Signed by maker/drawer, 3. Unconditional promise/order, 4. Fixed amount of money, 5. Payable on demand or definite time, 6. Payable to order or bearer.
Holder in Due Course (HDC)
A crucial concept related to negotiable instruments is the Holder in Due Course (HDC). An HDC is a holder who takes an instrument for value, in good faith, and without notice of any claim or defense against it. HDCs receive special protection, meaning they can often enforce the instrument even if the original parties had defenses.
The concept of a Holder in Due Course (HDC) is central to negotiable instruments. An HDC is a holder who takes an instrument for value, in good faith, and without notice of any claim or defense against it. This status grants the HDC significant legal advantages, allowing them to enforce the instrument free from most personal defenses that could have been raised against the original payee. This protection is a cornerstone of commercial paper, facilitating its free circulation. The requirements for HDC status are strict and are designed to protect innocent purchasers of negotiable instruments.
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Key Takeaways for REG
For the CPA REG exam, focus on memorizing the six requirements for negotiability. Understand the distinction between drafts and notes, and 'order' vs. 'bearer' paper. Be prepared to identify instruments that are NOT negotiable and to understand the basic concept and importance of a Holder in Due Course.
Learning Resources
The official legal text outlining the rules and definitions for negotiable instruments in the United States.
A clear and concise explanation of negotiable instruments, their types, and their significance in finance.
A resource specifically tailored for CPA exam preparation, focusing on the REG section's coverage of negotiable instruments.
A free online course module that breaks down the legal aspects of negotiable instruments.
A video tutorial explaining the key concepts of UCC Article 3, including negotiable instruments.
A video detailing the concept of a Holder in Due Course and its implications.
A glossary definition from Cornell's Legal Information Institute, providing a legal perspective on negotiable instruments.
The official source for information on the Uniform Commercial Code, including its various articles.
A blog post offering tips and explanations for tackling negotiable instruments on the CPA REG exam.
An explanation from the Small Business Administration on common types of negotiable instruments like promissory notes and checks.