A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to ...
, which promises the payment of money without condition, which may be paid either on demand or at a future date. The term has different meanings depending on the use of the term as it is used in the application of different laws, and depending in which country and context it is used.
Concept of negotiability
William Searle Holdsworth
defines the concept of negotiability as follows:
#Negotiable instruments are transferable under the following circumstances: they are transferable by delivery where they are made payable to the bearer, they are transferable by delivery and endorsement where they are made payable to order.
Consideration is a concept of English common law and is a necessity for simple contracts but not for special contracts (contracts by deed). The concept has been adopted by other common law jurisdictions.
The court in '' Currie v Misa'' decla ...
#The transferee acquires a good title, even though the transferor had a defective or no title.
Commonwealth of Nations
The Commonwealth of Nations, simply referred to as the Commonwealth, is a political association of 56 member states, the vast majority of which are former territories of the British Empire. The chief institutions of the organisation are the C ...
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 1890 in Canada, Bills of Exchange Act 1908
in New Zealand, Bills of Exchange Act 1909 in Australia, the
Negotiable Instruments Act, 1881
Negotiable Instruments Act, 1881 is an act in India dating from the British colonial rule, that is still in force largely unchanged.
The history of the present Act is a long one. The Act was originally drafted in 1866 by the 3rd Indi ...
in India and the Bills of Exchange Act 1914 in Mauritius.
Additionally most Commonwealth jurisdictions have separate Cheques Acts providing for additional protections for bankers collecting unendorsed or irregularly endorsed cheques, providing that cheques that are crossed and marked 'not negotiable' or similar are not transferable, and providing for electronic presentation of cheques in inter-bank cheque clearing systems.
In India, during the Mauryan period in the 3rd century BCE, an instrument called adesha
was in use, which was an order on a banker desiring him to pay the money of the note to a third person, which corresponds to the definition of a bill of exchange as we understand it today.
The ancient Romans are believed to have used an early form of cheque known as ''praescriptiones'' in the 1st century BCE
and 2,000-year-old Roman
A promissory note, sometimes referred to as a note payable, is a legal instrument (more particularly, a financing instrument and a debt instrument), in which one party (the ''maker'' or ''issuer'') promises in writing to pay a determinate sum of ...
s have been found.
Common prototypes of bills of exchanges and promissory notes originated in China
, where special instruments called ''fey tsien'' which were used to safely transfer money over long distances during the reign of the
The Tang dynasty (, ; zh, t= ), or Tang Empire, was an imperial dynasty of China that ruled from 618 to 907 AD, with an interregnum between 690 and 705. It was preceded by the Sui dynasty and followed by the Five Dynasties and Ten Kingdo ...
in the 8th century.
In about 1150 the
, colors = White mantle with a red cross
, colors_label = Attire
, march =
, mascot = Two knights riding a single horse
, equipment ...
issued an early form of bank notes to departing pilgrims in exchange for a deposit of valuables at a local Templar preceptory in a European country, which could be cashed by the pilgrim concerned on arrival in the Holy land, by presenting the note to a Templar preceptory there.
In the mid-13th century, the
The Ilkhanate, also spelled Il-khanate ( fa, ایل خانان, ''Ilxānān''), known to the Mongols as ''Hülegü Ulus'' (, ''Qulug-un Ulus''), was a khanate established from the southwestern sector of the Mongol Empire. The Ilkhanid realm, ...
Iran, officially the Islamic Republic of Iran, and also called Persia, is a country located in Western Asia. It is bordered by Iraq and Turkey to the west, by Azerbaijan and Armenia to the northwest, by the Caspian Sea and Turkmen ...
printed the "cha" or "chap" which was used as paper money for limited use for transactions between the court and the merchants for about three years before it collapsed. The collapse was caused by the court accepting the "cha" only at progressive discount.
Later, such documents were used for money transfer by Middle Eastern merchants, who had used the prototypes of bills of exchange (" suftadja
" or " softa
") from the 8th century to present. Such prototypes came to be used later by the Iberian and Italian merchants in the 12th century. In Italy in the 13–15th centuries, bills of exchange and promissory notes obtained their main features, while further phases of their development have been associated with France (16–18th centuries, where the endorsement had appeared) and Germany (19th century, formalization of Exchange Law). The first mention of the use of bills of exchange in English statutes dates from 1381, under
Richard II (6 January 1367 – ), also known as Richard of Bordeaux, was King of England from 1377 until he was deposed in 1399. He was the son of Edward the Black Prince, Prince of Wales, and Joan, Countess of Kent. Richard's father di ...
; the statute mandates the use of such instruments in England, and prohibits the future export of gold and silver
Specie may refer to:
* Coins or other metal money in mass circulation
* Bullion coins
* Hard money (policy)
* Commodity money
* Specie Circular
The Specie Circular is a United States presidential executive order issued by President Andrew Jac ...
, in any form, to settle foreign commercial transactions. English exchange law was different than continental European law because of different legal systems; the English system was adopted later in the United States.
In England, two of the main reasons why the use of negotiable instruments became so popular was:
1. Carrying large amounts of coins from one place to the other was deemed unsafe, so the usage of negotiable instruments was to prevent merchants from being robbed off their coins either on land or by sea.
2. During the 1300s, there was an increase in the use of "counterfeit English money", so the aim of the English Crown was to eradicate the exchanges that were made between genuine English coins and "foreign debased coinage". As such, statutes such as the Statute of Money of 1335 and 1379 were implemented to prevent the importation of money that was deemed as counterfeit, and also to prevent the exportation of valuable items like gold and silver in the absence of any special licenses.
The modern emphasis on negotiability may also be traced to Lord Mansfield
[ Germanic ] Lombards
The Lombards () or Langobards ( la, Langobardi) were a Germanic people who ruled most of the Italian Peninsula from 568 to 774.
The medieval Lombard historian Paul the Deacon wrote in the '' History of the Lombards'' (written between 787 an ... documents may also have some elements of negotiability.
Distinguished from other types of contracts
A negotiable instrument can serve to convey value constituting at least part of the performance of a
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to ..., albeit perhaps not obvious in contract formation, in terms inherent in and arising from the requisite offer and acceptance
Offer and acceptance are generally recognised as essential requirements for the formation of a contract, and analysis of their operation is a traditional approach in contract law. The offer and acceptance formula, developed in the 19th century, id ... and conveyance of consideration. The underlying contract contemplates the right to hold the instrument as, and to negotiate the instrument to, a ''holder in due course'', the payment on which is at least part of the performance of the contract to which the negotiable instrument is linked. The instrument, memorializing: (1) the power to demand payment; and, (2) the right to be paid, can move, for example, in the instance of a " bearer instrument
A bearer instrument is a document that entitles the holder of the document to rights of ownership or title to the underlying property, such as shares or bonds. Unlike normal registered instruments, no record is kept of who owns bearer instrument ...", wherein the possession of the document itself attributes and ascribes the right to payment. Certain exceptions exist, such as instances of loss or theft of the instrument, wherein the possessor of the note may be a holder, but not necessarily a holder in due course. Negotiation requires a valid ''endorsement'' of the negotiable instrument.
The consideration constituted by a negotiable instrument is cognizable as the value given up to acquire it (benefit) and the consequent loss of value (detriment) to the prior holder; thus, no separate consideration is required to support an accompanying contract assignment. The instrument itself is understood as memorializing the right for, and power to demand, payment, and an obligation for payment evidenced by the instrument itself with possession as a holder in due course being the touchstone for the right to, and power to demand, payment. In some instances, the negotiable instrument can serve as the writing memorializing a contract, thus satisfying any applicable statute of frauds
The Statute of Frauds (29 Car 2 c 3) (1677) was an Act of the Parliament of England. It required that certain types of contracts, wills, and grants, and assignment or surrender of leases or interest in real property must be in writing and sign ... as to that contract.
The holder in due course
The rights of a
holder in due course
In commercial law, a holder in due course (HDC) is someone who takes a negotiable instrument in a value-for-value exchange without reason to doubt that the instrument will be paid. If the instrument is later found not to be payable as written, a ho ... of a negotiable instrument are qualitatively, as matters of law, superior to those provided by ordinary species of contracts:
* The rights to payment are not subject to set-off, and do not rely on the validity of the underlying contract giving rise to the debt (for example if a cheque was drawn for payment for goods delivered but defective, the drawer is still liable on the cheque)
* No notice need be given to any party liable on the instrument for transfer of the rights under the instrument by negotiation. However, payment by the party liable to the person previously entitled to enforce the instrument "counts" as payment on the note until adequate notice has been received by the liable party that a different party is to receive payments from then on. .C.C. §3-602(b)* Transfer free of equities—the holder in due course can hold better title than the party he obtains it from (as in the instance of negotiation of the instrument from a mere holder to a holder in due course)
Negotiation often enables the transferee to become the party to the contract through a contract assignment (provided for explicitly or by operation of law) and to enforce the contract in the transferee-assignee's own name. Negotiation can be effected by endorsement and delivery ( order instruments), or by delivery alone ( bearer instrument
A bearer instrument is a document that entitles the holder of the document to rights of ownership or title to the underlying property, such as shares or bonds. Unlike normal registered instruments, no record is kept of who owns bearer instrument ...s).
Promissory notes and bills of exchange are two primary types of negotiable instruments. The following chart shows the main differences:
Although possibly non-negotiable, a
A promissory note, sometimes referred to as a note payable, is a legal instrument (more particularly, a financing instrument and a debt instrument), in which one party (the ''maker'' or ''issuer'') promises in writing to pay a determinate sum of ... may be a negotiable instrument if it is an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand to the ''payee'', or at fixed or determinable future time, a sum certain in money, to order or to bearer. The law applicable to the specific instrument will determine whether it is a negotiable instrument or a non-negotiable instrument.
Bank notes are frequently referred to as promissory notes, a promissory note made by a bank and payable to bearer on demand. According to section 4 of India's Negotiable Instruments Act, 1881
Negotiable Instruments Act, 1881 is an act in India dating from the British colonial rule, that is still in force largely unchanged.
The history of the present Act is a long one. The Act was originally drafted in 1866 by the 3rd Indi ..., "a Promissory Note is a writing (not being a bank note or currency note), containing an unconditional undertaking, signed by the maker to pay a certain sum of money only to or to the order of a certain person or the bearer of the instrument".
Bill of exchange
A bill of exchange or "draft" is a written order by the ''
A drawer is a box-shaped container inside a piece of furniture that can be pulled out horizontally to access its contents. Drawers are built into numerous types of furniture, including cabinets, chests of drawers (bureaus), desks, and th ...'' to the '' drawee'' to pay money to the '' payee
A payment is the voluntary tender of money or its equivalent or of things of value by one party (such as a person or company) to another in exchange for goods, or services provided by them, or to fulfill a legal obligation. The party making the ...''. A common type of bill of exchange is the cheque
A cheque, or check ( American English; see spelling differences) is a document that orders a bank (or credit union) to pay a specific amount of money from a person's account to the person in whose name the cheque has been issued. The p ... (''check'' in American English
American English, sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. English is the most widely spoken language in the United States and in most circumstances i ...), 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. Prior to the advent of paper currency, bills of exchange were a common means of exchange. They are not used as often today.
A bill of exchange is essentially an order made by one person to another to pay money to a third person. A bill of exchange requires in its inception three parties—the drawer, the drawee, and the payee. The person who draws the bill is called the drawer. He gives the order to pay money to the third party. The party upon whom the bill is drawn is called the drawee. He is the person to whom the bill is addressed and who is ordered to pay. He becomes an acceptor when he indicates his willingness to pay the bill. The party in whose favor the bill is drawn or is payable is called the payee. The parties need not all be distinct persons. Thus, the drawer may draw on himself payable to his own order.
A bill of exchange may be endorsed by the payee in favour of a third party, who may in turn endorse it to a fourth, and so on indefinitely. The "holder in due course" may claim the amount of the bill against the drawee and all previous endorsers, regardless of any counterclaims that may have disabled the previous payee or endorser from doing so. This is what is meant by saying that a bill is negotiable.
In some cases a bill is marked "not negotiable"—see crossing of cheques. In that case it can still be transferred to a third party, but the third party can have no better right than the transferor.
In the United States
In the United States, Articles 3 and 4 of the
Uniform Commercial Code
The Uniform Commercial Code (UCC), first published in 1952, is one of a number of Uniform Acts that have been established as law with the goal of harmonizing the laws of sales and other commercial transactions across the United States through U ... (UCC) govern the issuance and transfer of negotiable instruments, unless the instruments are governed by Article 8 of the UCC. The various state law enactments of UCC §§ 3–104(a) through (d) set forth the legal definition of what is and what is not a ''negotiable instrument'':
Thus, for a writing to be a negotiable instrument under Article 3, the following requirements must be met:
# The promise or order to pay must be unconditional;
# The payment must be a specific sum of money, although interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is dist ... may be added to the sum;
# The payment must be made on demand or at a definite time;
# The instrument must not require the person promising payment to perform any act other than paying the money specified;
# The instrument must be payable to bearer or to order.
The latter requirement is referred to as the "words of negotiability": a writing which does not contain the words "to the order of" (within the four corners of the instrument or in endorsement on the note or in allonge
An allonge (from French ''allonger'', "to draw out") is a slip of paper affixed to a negotiable instrument, as a bill of exchange, for the purpose of receiving additional endorsements for which there may not be sufficient space on the bill itself. ...) or indicate that it is payable to the individual holding the contract document (analogous to the holder in due course) is not a negotiable instrument and is not governed by Article 3, even if it appears to have 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
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets.
Because ...) and is not payable to order (i.e. if it just reads "pay John Doe") then it is treated as a negotiable instrument.
UCC Article 3 does not apply to money, to payment orders governed by Article 4A, or to securities governed by Article 8.
Negotiation and endorsement
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 "endorsing" (from Latin ''dorsum'', the back + ''in''), that is placing one's
A signature (; from la, signare, "to sign") is a handwritten (and often stylized) depiction of someone's name, nickname, or even a simple "X" or other mark that a person writes on documents as a proof of identity and intent. The writer of a ... on the back of 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 ''endorsement''. There are five types of endorsements contemplated by the Code, covered in UC
Article 3, Sections 204–206
*An endorsement which purports to transfer the instrument to a specified person is a ''special endorsement'' – for example, "Pay to the order of Amy";
*An endorsement by the payee or holder which does not contain any additional notation (thus purporting to make the instrument payable to bearer) is an ''endorsement in blank'' or '' blank endorsement;''
*An endorsement which purports to require that the funds be applied in a certain manner (e.g. "", "for collection") is a ''restrictive endorsement''; and,
*An endorsement purporting to disclaim retroactive liability is called a ''qualified endorsement'' (through the inscription of the words "without recourse" as part of the endorsement on the instrument or in
An allonge (from French ''allonger'', "to draw out") is a slip of paper affixed to a negotiable instrument, as a bill of exchange, for the purpose of receiving additional endorsements for which there may not be sufficient space on the bill itself. ... to the instrument).
*An endorsement purporting to add terms and conditions is called a ''conditional endorsement'' – for example, "Pay to the order of Amy, if she rakes my lawn next Thursday November 15th, 2007". The UCC states that these conditions may be disregarded.
If a note or draft is negotiated to a person who acquires the instrument
#in good faith
In human interactions, good faith ( la, bona fides) is a sincere intention to be fair, open, and honest, regardless of the outcome of the interaction. Some Latin phrases have lost their literal meaning over centuries, but that is not the case ...;
Value or values may refer to:
Ethics and social
* Value (ethics) wherein said concept may be construed as treating actions themselves as abstract objects, associating value to them
** Values (Western philosophy) expands the notion of value bey ...;
#without notice of any defense
Defense or defence may refer to:
Tactical, martial, and political acts or groups
* Defense (military), forces primarily intended for warfare
* Civil defense, the organizing of civilians to deal with emergencies or enemy attacks
* Defense indust ...s to payment,
the transferee is a '' holder in due course
In commercial law, a holder in due course (HDC) is someone who takes a negotiable instrument in a value-for-value exchange without reason to doubt that the instrument will be paid. If the instrument is later found not to be payable as written, a ho ...'' and can enforce the instrument ''without'' being subject to defenses which the maker of the instrument would be able to assert against the original payee, except for certain ''real defenses''. These real defenses include (1) forgery of the instrument; (2) fraud as to the nature of the instrument being signed; (3) alteration of the instrument; (4) incapacity of the signer to contract; (5) infancy of the signer; (6) duress; (7) discharge in bankruptcy; and, (8) the running of a statute of limitations as to the validity of the instrument.
The ''holder-in-due-course rule'' is a ''rebuttable presumption'' that makes the free transfer of negotiable instruments feasible in the modern economy. A person or entity purchasing an instrument in the ordinary course of business can reasonably expect that it will be paid when presented to, and not subject to dishonor by, the maker, without involving itself in a dispute between the maker and the person to whom the instrument was first issued (this can be contrasted to the lesser rights and obligations accruing to mere holders). Article 3 of the Uniform Commercial Code as enacted in a particular State's law contemplate ''real defenses'' available to purported holders in due course.
The foregoing is the theory and application presuming compliance with the relevant law. Practically, the obligor-payor on an instrument who feels he has been defrauded or otherwise unfairly dealt with by the payee may nonetheless refuse to pay even a holder in due course, requiring the latter to resort to litigation
A lawsuit is a proceeding by a party or parties against another in the civil court of law. The archaic term "suit in law" is found in only a small number of laws still in effect today. The term "lawsuit" is used in reference to a civil act ... to recover on the instrument.
While bearer instruments are rarely created as such, a holder of
Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of rarely more than 270 days. In layperson terms, it is like an " IOU" but can be bought and sold because its buyers and sellers have som ... with the holder designated as payee can change the instrument to a bearer instrument by an endorsement. The proper holder simply signs the back of the instrument and the instrument becomes bearer paper, although in recent years, third party checks are not being honored by most banks unless the original payee has signed a notarized document stating such.
Alternatively, an individual or company may write a check payable to "cash" or "bearer" and create a bearer instrument. Great care should be taken with the security of the instrument, as it is legally almost as good as cash.
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:
* Bills of lading and other documents of title, which are governed by Article 7 of the Code. However, under
Admiralty law or maritime law is a body of law that governs nautical issues and private maritime disputes. Admiralty law consists of both domestic law on maritime activities, and private international law governing the relationships between priv ..., a bill of lading may either be a negotiable or 'order' bill of lading or a nonnegotiable or 'straight' bill of lading.
In common law, a deed is any legal instrument in writing which passes, affirms or confirms an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions, sealed. It is commonly associated with transferrin ...s and other documents conveying interests in real estate, although a mortgage
A mortgage loan or simply mortgage (), in civil law jurisdicions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any p ... may secure a promissory note which is governed by Article 3
An IOU ( abbreviated from the phrase "I owe you") is usually an informal document acknowledging debt. An IOU differs from a promissory note in that an IOU is not a negotiable instrument and does not specify repayment terms such as the time of ...s
* Letters of credit
A letter of credit (LC), also known as a documentary credit or bankers commercial credit, or letter of undertaking (LoU), is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exp ..., which are governed by Article 5 of the Code
Although often considered foundational in business law, the modern relevance of negotiability has been questioned.
[Mann RJ (1996)] Negotiability can be traced back to the 1700s and Lord Mansfield, when
Searching for Negotiability in Payment and Credit Systems
''UCLA Law Review''.
Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are a ... and liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Li ... was relatively scarce. [ The holder in due course rule has been limited by various statutes.] [ Concerns have also been raised that the holder in due course rule does not align the incentives of the mortgage originators and the assignees efficiently.] [Greenlee MB, Fitzpatrck IV TJ. (2008)]
Reconsidering the Application of the Holder in Due Course Rule to Home Mortgage Notes
Federal Reserve Bank of Cleveland.
A bearer instrument is a document that entitles the holder of the document to rights of ownership or title to the underlying property, such as shares or bonds. Unlike normal registered instruments, no record is kept of who owns bearer instrument ...
A hundi or hundee is a financial instrument that developed in Medieval India for use in trade and credit transactions. Hundis are used as a form of remittance instrument to transfer money from place to place, as a form of credit instrument or IO ...
* Negotiable cow
Bill of Exchange FAQ on TheBenche.com
Negotiable instrument law
Accounting source documents
Money market instruments