Negotiable instrument
Encyclopedia
A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time. According to the Section 13 of the Negotiable Instruments Act, 1881 in India, a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer. So, there are just three types of negotiable instruments such as promissory note
, bill of exchange and cheque
. Cheque also includes Demand Draft [Section 85A].
More specifically, it is a document contemplated by a contract
, which (1) warrants the payment of money, the promise of or order for conveyance of which is unconditional; (2) specifies or describes the payee, who is designated on and memorialized by the instrument; and (3) is capable of change through transfer by valid negotiation of the instrument.
As payment of money is promised subsequently, the instrument itself can be used by the holder in due course
as a store of value; although, instruments can be transferred for amounts in contractual exchange that are less than the instrument’s face value (known as “discounting”).
Under United States law, Article 3 of the Uniform Commercial Code
as enacted in the applicable State law governs the use of negotiable instruments, except banknotes (“Federal Reserve Notes”, aka "paper dollar
s").
, albeit perhaps not obvious in contract formation, in terms inherent in and arising from the requisite offer and acceptance 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
', 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
as to that contract.
of a negotiable instrument are qualitatively, as matters of law, superior to those provided by ordinary species of contracts:
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
s). In addition, the rights and obligations accruing to the transferee can be affected by the rule of derivative title, which does not allow a property owner to transfer rights in a piece of property greater than his own.
they used special instruments called feitsyan for the safe transfer of money over long distances. Later such document for money transfer used by Arab merchants, who had used the prototypes of bills of exchange – suftadja and hawala in 10–13th centuries, then such prototypes had used by Italian merchants in the 12th century. In Italy in 13–15th centuries bill of exchange and promissory note obtain their main features and further phases of its development have been associated with France (16–18th centuries, where the endorsement had appeared) and Germany (19th century, formalization of Exchange Law). In England (and later in the U.S.) Exchange Law was different from continental Europe because of different legal systems.
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, certain in money, to order or to bearer. (see Sec.194) Bank note is frequently referred to as a promissory note, a promissory note made by a bank and payable to bearer on demand.
(check in American English
), 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 an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at fixed or determinable future time a sum certain in money to order or to bearer. (Sec.126)
It 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. (Sec.62) 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. (see Sec. 8)
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 UK, Bills of Exchange Act 1908 in New Zealand, The Negotiable Instrument Act 1881 in India and The Bills of Exchange Act 1914 in Mauritius. The Bills of Exchange Act:
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.
The 1911 Encyclopædia Britannica Eleventh Edition
has a comprehensive article on the Bill of Exchange, detailing its history and operation, as understood at the time of its publication.
, Article 3 and Article 4 of the Uniform Commercial Code
govern the issuance and transfer of negotiable instruments. The various State law enactments of Uniform Commercial Code §§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 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
) 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
) and is not payable to order (i.e. if it just reads "pay John Doe") then it is treated as a negotiable instrument.
on the instrument (“endorsement”): 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 UCC Article 3, Sections 204–206:
If a note or draft is negotiated to a person who acquires the instrument
the transferee is a holder in due course
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
to recover on the instrument.
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.
Promissory note
A promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
, bill of exchange and cheque
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
. Cheque also includes Demand Draft [Section 85A].
More specifically, it is a document contemplated by a contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
, which (1) warrants the payment of money, the promise of or order for conveyance of which is unconditional; (2) specifies or describes the payee, who is designated on and memorialized by the instrument; and (3) is capable of change through transfer by valid negotiation of the instrument.
As payment of money is promised subsequently, the instrument itself can be used by the holder in due course
Holder in due course
The Holder in Due Course doctrine is a rule in commercial law that protects a purchaser of debt. The doctrine insulates the purchaser of debt, or other obligation to pay, against charges that either party to the original transaction might have had against the other.-Example:Suppose A promised to...
as a store of value; although, instruments can be transferred for amounts in contractual exchange that are less than the instrument’s face value (known as “discounting”).
Under United States law, Article 3 of the Uniform Commercial Code
Uniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
as enacted in the applicable State law governs the use of negotiable instruments, except banknotes (“Federal Reserve Notes”, aka "paper dollar
Dollar
The dollar is the name of the official currency of many countries, including Australia, Belize, Canada, Ecuador, El Salvador, Hong Kong, New Zealand, Singapore, Taiwan, and the United States.-Etymology:...
s").
Negotiable instruments distinguished from other types of contracts
A negotiable instrument can serve to convey value constituting at least part of the performance of a contractContract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
, albeit perhaps not obvious in contract formation, in terms inherent in and arising from the requisite offer and acceptance 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
Bearer instrument
A bearer instrument is a document that indicates that the owner of the document has title to property, such as shares or bonds. Bearer instruments differ from normal registered instruments, in that no records are kept of who owns the underlying property, or of the transactions involving transfer of...
', 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
Statute of frauds
The statute of frauds refers to the requirement that certain kinds of contracts be memorialized in a signed writing with sufficient content to evidence the contract....
as to that contract.
The holder in due course
The rights of a holder in due courseHolder in due course
The Holder in Due Course doctrine is a rule in commercial law that protects a purchaser of debt. The doctrine insulates the purchaser of debt, or other obligation to pay, against charges that either party to the original transaction might have had against the other.-Example:Suppose A promised to...
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-offSet-off (law)In law, a set-off is a statutory defense to the whole or to a portion of a plaintiff's claim. It had no existence under the English common law, being created by 2 Geo. II c. 22 for the relief of insolvent debtors, although set-off was recognized in equity...
, 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. [U.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
Bearer instrument
A bearer instrument is a document that indicates that the owner of the document has title to property, such as shares or bonds. Bearer instruments differ from normal registered instruments, in that no records are kept of who owns the underlying property, or of the transactions involving transfer of...
s). In addition, the rights and obligations accruing to the transferee can be affected by the rule of derivative title, which does not allow a property owner to transfer rights in a piece of property greater than his own.
History
Common prototypes of bills of exchanges and promissory notes originated in China. Here, in the 8th century during the reign of the Tang DynastyTang Dynasty
The Tang Dynasty was an imperial dynasty of China preceded by the Sui Dynasty and followed by the Five Dynasties and Ten Kingdoms Period. It was founded by the Li family, who seized power during the decline and collapse of the Sui Empire...
they used special instruments called feitsyan for the safe transfer of money over long distances. Later such document for money transfer used by Arab merchants, who had used the prototypes of bills of exchange – suftadja and hawala in 10–13th centuries, then such prototypes had used by Italian merchants in the 12th century. In Italy in 13–15th centuries bill of exchange and promissory note obtain their main features and further phases of its development have been associated with France (16–18th centuries, where the endorsement had appeared) and Germany (19th century, formalization of Exchange Law). In England (and later in the U.S.) Exchange Law was different from continental Europe because of different legal systems.
Classes
Promissory notes and bills of exchange are two primary types of negotiable instruments.Promissory note
A promissory notePromissory note
A promissory note is a negotiable instrument, wherein one party makes an unconditional promise in writing to pay a determinate sum of money to the other , either at a fixed or determinable future time or on demand of the payee, under specific terms.Referred to as a note payable in accounting, or...
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, certain in money, to order or to bearer. (see Sec.194) Bank note is frequently referred to as a promissory note, a promissory note made by a bank and payable to bearer on demand.
Bill of exchange
A bill of exchange or "draft" is a written order by the drawer to the drawee to pay money to the payee. A common type of bill of exchange is the chequeCheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
(check in American English
American English
American English is a set of dialects of the English language used mostly in the United States. Approximately two-thirds of the world's native speakers of English live in the United States....
), 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 an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at fixed or determinable future time a sum certain in money to order or to bearer. (Sec.126)
It 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. (Sec.62) 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. (see Sec. 8)
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
Crossing of cheques
Any cheque crossed with two parallel lines means that the cheque can only be deposited directly into an account with a bank and cannot be immediately cashed by a bank over the counter. By using crossed cheques, cheque writers can effectively protect the cheques they write from being stolen and...
. 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 Commonwealth
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 1882Bills of Exchange Act 1882
The Bills of Exchange Act 1882 is a United Kingdom Act of Parliament concerning bills of exchange....
in the UK, Bills of Exchange Act 1908 in New Zealand, The Negotiable Instrument Act 1881 in India and The Bills of Exchange Act 1914 in Mauritius. The Bills of Exchange Act:
- defines a bill of exchange as: 'an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person, or to bearer.
- defines a cheque as: 'a bill of exchange drawn on a banker payable on demand'
- defines a promissory note as: 'an unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on demand, or at a fixed or determinable future time, a sum certain in money to or to the order of a specified person or to bearer.'
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.
The 1911 Encyclopædia Britannica Eleventh Edition
Encyclopædia Britannica Eleventh Edition
The Encyclopædia Britannica Eleventh Edition is a 29-volume reference work, an edition of the Encyclopædia Britannica. It was developed during the encyclopaedia's transition from a British to an American publication. Some of its articles were written by the best-known scholars of the time...
has a comprehensive article on the Bill of Exchange, detailing its history and operation, as understood at the time of its publication.
In the United States
In the United StatesUnited States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, Article 3 and Article 4 of the Uniform Commercial Code
Uniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
govern the issuance and transfer of negotiable instruments. The various State law enactments of Uniform Commercial Code §§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 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
Allonge
Allonge , 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. An endorsement written on the allonge is deemed to be written 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
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
) and is not payable to order (i.e. if it just reads "pay John Doe") then it is treated as a negotiable instrument.
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 placing one's signatureSignature
A signature is a handwritten depiction of someone's name, nickname, or even a simple "X" that a person writes on documents as a proof of identity and intent. The writer of a signature is a signatory. Similar to a handwritten signature, a signature work describes the work as readily identifying...
on the instrument (“endorsement”): 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 UCC 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 endorsementBlank endorsementBlank endorsement of a financial instrument such as a check is only a signature, not indicating the payee. The effect of this is that it is payable only to the bearer – legally, it transforms an order instrument into a bearer instrument...
; - 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 allonge 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 11th, 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 faithGood faithIn philosophy, the concept of Good faith—Latin bona fides “good faith”, bona fide “in good faith”—denotes sincere, honest intention or belief, regardless of the outcome of an action; the opposed concepts are bad faith, mala fides and perfidy...
; - for valueValue (economics)An economic value is the worth of a good or service as determined by the market.The economic value of a good or service has puzzled economists since the beginning of the discipline. First, economists tried to estimate the value of a good to an individual alone, and extend that definition to goods...
; - without notice of any defenseDefense (legal)In civil proceedings and criminal prosecutions under the common law, a defendant may raise a defense in an attempt to avoid criminal or civil liability...
s to payment,
the transferee is a holder in due course
Holder in due course
The Holder in Due Course doctrine is a rule in commercial law that protects a purchaser of debt. The doctrine insulates the purchaser of debt, or other obligation to pay, against charges that either party to the original transaction might have had against the other.-Example:Suppose A promised to...
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
Lawsuit
A lawsuit or "suit in law" is a civil action brought in a court of law in which a plaintiff, a party who claims to have incurred loss as a result of a defendant's actions, demands a legal or equitable remedy. The defendant is required to respond to the plaintiff's complaint...
to recover on the instrument.
Usage
While bearer instruments are rarely created as such, a holder of commercial paperCommercial paper
In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued by large banks and corporations to get money to meet short term debt obligations , and is only backed by an issuing bank or...
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
Cheque
A cheque is a document/instrument See the negotiable cow—itself a fictional story—for discussions of cheques written on unusual surfaces. that orders a payment of money from a bank account...
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.
Exceptions
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
- DeedDeedA deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...
s and other documents conveying interests in real estate, although a mortgage may secure a promissory note which is governed by Article 3 - IOUIOU (debt)An IOU 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 repayment. IOUs usually specify the debtor, the amount owed, and sometimes the creditor...
s - Letters of credit, which are governed by Article 5 of the Code
- SecuritiesSecurity (finance)A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
, such as stockStockThe capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
s and bondsBond (finance)In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
, which are governed by Article 8 of the Code
See also
- AvalAvalAval , in Spain, is a joint commitment to payment of an obligation in favor of the creditor or beneficiary. It is granted by a third party, in case the principal debtor does not fulfil the obligation of payment of a credit title....
- Bearer instrumentBearer instrumentA bearer instrument is a document that indicates that the owner of the document has title to property, such as shares or bonds. Bearer instruments differ from normal registered instruments, in that no records are kept of who owns the underlying property, or of the transactions involving transfer of...
- Negotiable cowNegotiable cowBoard of Inland Revenue v Haddock is a fictitious legal case written by the humorist A. P. Herbert for Punch magazine as part of his series of Misleading Cases in the Common Law. It was first published in book form in More Misleading Cases in the Common Law...