Business, Legal & Accounting Glossary
A negotiable instrument is a specialized type of contract for the payment of money that is unconditional and capable of transfer by negotiation. Common examples include cheques and banknotes (paper money).
A written document that represents an unconditional promise to pay a specified amount of money upon the demand of its owner. Examples include checks and promissory notes. Negotiable instruments can be transferred from one person to another, as when you write “pay to the order of” on the back of a check and turn it over to someone else.
n. check, promissory note, bill of exchange, security or any document representing money payable which can be transferred to another by handing it over (delivery) and/or endorsing it (signing one’s name on the back either with no instructions or directing it to another, such as “pay to the order of Pamela Townsend”).
A negotiable instrument is not a contract, as contract formation requires an offer, acceptance, and consideration, none of which are elements of a negotiable instrument. Unlike ordinary contract documents, the right to the performance of a negotiable instrument is linked to the possession of the document itself (with certain exceptions such as loss or theft).
The rights of the payee (or holder in due course) are better than those provided by ordinary contracts as follows:
Negotiation enables the transferee to become the party to the contract and to enforce the contract in his own name. Negotiation can be effected by endorsement and delivery (order instruments), or by delivery alone (bearer instruments). in addition, it includes the rule of a derivative title which does not allow a property owner to transfer rights in a piece of property greater than his own.
The two primary classes of negotiable instruments are ‘promissory notes’ and ‘bills of exchange.’
The promissory note is a written promise by the maker to pay money to the payee. The most common type of promissory note is a banknote, which is defined as a promissory note made by a bank and payable to the bearer on demand.
A bill of exchange is a written order by the drawer to the drawee to pay money to the payee. The most common type of bill of exchange is the cheque, which is defined as a bill of exchange drawn on a banker and payable on demand. Bills of exchange are used primarily in international trade, and are written orders by one person to his bank to pay the bearer a specific sum on a specific date sometime in the future.
Prior to the advent of paper currency, bills of exchange were a more significant part of trade. They are a rather ancient form of instrument: they were used by medieval trade fairs, such as the Frankfurt Trade Fair.
In the commonwealth, almost all jurisdictions have codified the law relating to negotiable instruments in a Bills of Exchange Act, e.g. Bills of Exchange Act 1882 in the UK, Bills of Exchange Act 1908 in New Zealand. The Bills of Exchange Act:
Additionally, most commonwealth jurisdictions have separate Cheques Acts providing for additional protections for bankers collecting unendorsed or irregularly indorsed cheques, providing that cheques that are crossed and marked ‘not negotiable’ or similar are not transferrable, and providing for electronic presentation of cheques in inter-bank cheque clearing systems.
In the United States, Article 3 and Article 4 of the Uniform Commercial Code govern the issuance and negotiation of negotiable instruments.
For a writing to be a negotiable instrument under Article 3, the following requirements must be met:
The latter requirement is referred to as the “words of negotiability”: a writing which does not contain the words “to the order of” or indicate that it is payable to the person in possession, is not a negotiable instrument and is not governed by Article 3, even if it has all of the other features of negotiability. The only exception is that if an instrument meets the definition of a cheque (a bill of exchange payable on demand and drawn on a bank) and is not payable to order (i.e. if it just reads “pay John Doe”) then it is treated as a negotiable instrument.
Persons other than the original obligor and obligee can become parties to a negotiable instrument. The most common manner in which this is done is by placing one’s signature on the instrument: if the person who signs does so with the intention of obtaining payment of the instrument or acquiring or transferring rights to the instrument, the signature is called an indorsement. An indorsement which transfers the instrument to a specified person is a special indorsement. An endorsement by the payee or holder which does not contain any additional notation (thus making the instrument payable to bearer) is a indorsement in blank. An indorsement which requires that the funds be applied in a certain manner (i.e. “for deposit only”, “for collection”) is a restrictive indorsement.
The most remarkable feature of a negotiable instrument is that if it is negotiated to a person who acquires the instrument i) in good faith ii) for value iii) without notice of any defences to payment, then the transferee is a holder in due course and can enforce the instrument without being subject to defences which the maker of the instrument would be able to assert against the original payee, except for certain real defences which are rarely applicable.
The holder in due course rule is what makes the free transfer of negotiable instruments feasible in the modern industrial economy: a person or company who purchases such an instrument in the ordinary course of business can reasonably expect that it will be paid when presented to the maker, without involving itself in a dispute between the maker and the person to whom the instrument was first issued.
The foregoing is the theory and the letter of the law: of course, in reality, the issuer of an instrument who feels he has been defrauded or otherwise rawly dealt with by the payee may nonetheless refuse to pay the holder in due course, requiring the latter to resort to litigation to recover on the instrument.
Under the Code, the following are not negotiable instruments, although the law governing obligations with respect to such items may be similar to or derived from the law applicable to negotiable instruments:
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This glossary post was last updated: 26th November, 2021 | 0 Views.