Financial instruments

Key Takeaways

• A financial instrument is a document that carries money value or records a money transaction, such as a check, a draft, a promissory note, a bond, or a certificate of deposit.
• A note is a promise to pay. A draft is an order telling someone else to pay, and a check is one kind of draft.
• A deed of trust is a security instrument rather than a financial instrument, because it pledges collateral instead of promising money.
• Washington's version of Uniform Commercial Code Article 3, RCW 62A.3-104, sets the test for which of these documents also qualify as negotiable instruments.

What It Means

Financial instruments are the documents, and now often the electronic records, that carry money value or record a money transaction. The list a real estate student needs is short: checks, drafts, promissory notes, bonds, and certificates of deposit. What ties them together is that each one either promises money or orders someone else to pay money, and many of them can be handed to a new holder who is then entitled to enforce them.

In a closing you touch two of these constantly. The earnest money check is an order telling a bank to pay. The Promissory Note the buyer signs is a promise to pay the lender a stated amount on stated terms. Both are financial instruments. The document people confuse with them is not one at all. A Deed Of Trust pledges the property as Collateral and gives the lender a remedy if the note goes unpaid, but it contains no promise of money on its own, so it is a security instrument. Keeping that split straight is what explains how a lender can sell the note while the security simply follows it. Bonds sit further out in the same family, on the side where real estate money is put to work as debt rather than as property.

How It Works in Washington

Washington adopted Article 3 of the Uniform Commercial Code as chapter 62A.3 RCW, and RCW 62A.3-104 is the section that sorts these documents. It defines a negotiable instrument as an unconditional promise or order to pay a fixed amount of money, payable to bearer or to order, payable on demand or at a definite time, and stating no other undertaking beyond the payment of money. RCW 62A.3-104(e) then draws the line students get tested on: an instrument is a note if it is a promise and a draft if it is an order. RCW 62A.3-104(f) defines a check as a draft, other than a documentary draft, payable on demand and drawn on a bank, or a cashier's check or teller's check, and adds that an instrument can still be a check even if its face calls it something else, such as a money order.

Two cautions follow for Washington practice. Financial instrument is the broad category and negotiable instrument is the narrow legal test, so a document can be one without being the other. And older course lists still use the phrase bill of exchange for what the current statute simply calls a draft. Brokers who want the surrounding financing vocabulary can start with the loan types every Washington broker should know.

Example

Nora buys a house in Olympia for $525,000. She writes a $10,000 earnest money check to the escrow company, and at closing she signs a promissory note for $420,000 secured by a deed of trust recorded against the property.

Sort the three documents. The check is a financial instrument, and under RCW 62A.3-104(f) it is also a negotiable instrument: a draft payable on demand and drawn on Nora's bank. The note is a financial instrument too, and because it is an unconditional promise to pay a fixed $420,000 on stated dates and adds no other undertaking, it meets the RCW 62A.3-104(a) test, which is why the lender can sell it into the secondary market a month after closing. The deed of trust is neither. It promises no money, it pledges a house, and it travels with whoever holds the note.

Common Mistakes and Exam Traps

• The note is the debt and the deed of trust is the security. A question asking which document creates the obligation to repay is asking about the note.
• A draft is an order to pay and a note is a promise to pay. RCW 62A.3-104(e) splits them on that single word.
• Not every financial instrument is a negotiable instrument. A promise that is conditional, or that adds a duty beyond paying money, fails the negotiability test in RCW 62A.3-104(a).
• Bill of exchange appears in older glossaries and textbooks. The current Washington statute calls that same document a draft.