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Negotiable Instruments
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

Written orders or promises to pay money that may be transferred from one person to another by delivery, or by endorsement and delivery, the full legal title thereby becoming vested in the transferee.  The negotiation of such an instrument to a holder in due course gives such holder the same rights as held by the original payee (promisee), free from defenses (except real defenses) that might defeat them.  Article 3 of the Uniform Commercial Code, entitled "Commercial Paper", is concerned with notes, drafts, checks, and certificates of deposit.  Most such instruments are negotiable in form.  Other types of negotiable property interests that are not commercial paper (e.g., stock and bond certificates, order or bearer bills or lading and warehouse receipts) are covered in other sections of the code, primarily Article 7.

Laws relating to commercial paper developed among traders and merchants in Europe through customs and practices considered to be appropriate for the fair and efficient conduct of business.  The body of common law provided a legal basis for the form and structure of commercial paper.  At a later time, the rules of law relating to commercial paper were codified by legislation.  The Uniform Negotiable Instruments Law was the first of the uniform business statutes drafted under the guidance of the Commissioners on Uniform State Laws.  The Uniform Negotiable Instruments Law has been adopted by all the states and is the basic pattern for Article 3 of the Uniform Commercial Code.

A negotiable instrument is commercial paper (promissory notes, checks, drafts or bills of exchange, and certificates of deposit).  A promissory note is 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 order or to bearer.  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 a fixed or determinable future time, a sum certain in money to order or to bearer.  A check is a bill of exchange drawn on a bank payable on demand.  A certificate of deposit is an acknowledgment by a bank of a receipt of money with an engagement to repay it.

A negotiable instrument must meet the following four requirements:

1.         It must be in writing and signed by the maker or drawee.

2.         It must contain an unconditional promise or order to pay a certain sum in money and no other promise, order, obligation, or power except such as is authorized by Article 3 of the Uniform Commercial Code.

3.         It must be payable on demand, or at a definite time.

4.         It must be payable either to order or to bearer.

There is no express requirement concerning the materials with which or on which a negotiable instrument must be written.  "Signed" includes any symbol executed or adopted by a party with present intention to authenticate a writing.  A conditional promise or order (unnegotiable) is evident (1) if it states that it is subject to or governed by any other agreement or (2) if it states that it is to be paid only out of a particular fund or source (with some exceptions).  For a sum to be certain, the amount must be capable of being calculated from data on the face of the note.  To be payable in money requires that it be paid in the medium of exchange adopted by the government as its currency.

A promise is an undertaking to pay and must be more than an acknowledgment of an obligation.  An order is a direction to pay and must be more than an authorization or request.  Instruments payable on demand include those payable at sight or on presentation and those in which no time for payment is stated.  Order paper is negotiated by the transferor's endorsing the paper and delivering it to the new holder.  It is possible to negotiate bearer paper by delivery without an endorsement; however, a transferee will usually ask for an endorsement so as to obtain the advantage of the broader contract liability.

A holder in due course is one who has taken the instrument under the following conditions:

1.        That it is complete and regular upon its face.

2.        That the individual became the holder of it before it was overdue, and without notice that it was previously dishonored, if such was the fact.

3.        That the holder took it in good faith and for value.

4.        That at the time it was negotiated, the holder had no notice of an infirmity in the instrument or defect in the title of the person negotiating it.

It is generally held that a holder in due course holds the instrument free from any defect of title of prior parties, and free from defenses available to prior parties among themselves, and may enforce payment of the instrument for the full amount thereof against all parties liable thereon.  The holder of a note is presumed to be the owner thereof, and may sue thereon in his or her own name.

Various forms of ENDORSEMENT include:

Special endorsement                                          Pay to the order of John Doe

                                                                               Signed:  Bill Doe


Blank endorsement                                              Signed:  Bill Doe


Restrictive endorsement                                     Pay to John Doe only

                                                                               Signed:  Bill Doe


Qualified endorsement                                        Pay without recourse to order of John Doe

                                                                               Signed:  Bill Doe


Conditional endorsement                                   On the election of the mayor in Greensboro , NC , Pay

                                                                              To the order of John Doe Signed:  Bill Doe


An unqualified endorser, who receives consideration, warrants to the transferee and to any subsequent holder who receives the instrument in good faith:

1.         Hat the endorser has good title to the instrument, or represents a person with title, and that the transfer is otherwise rightful.

2.         That all signatures are genuine or authorized.

3.         That the instrument has not been materially altered.

4.         That no defense of any prior party is good against him or her.

5.         That the endorser has no knowledge of any insolvency proceeding involving the payor.

A transferor without endorsement, who receives consideration, warrants to the transferee only who receives the instrument in good faith the same warranties.

Unless the instrument specifies otherwise, two or more persons (multiple signers) who sign as maker, acceptor, drawer, or endorser and as part of the same transactions are jointly and severally liable.  An accommodation party is one who signs the instrument in any capacity for the purpose of lending his or her name to another party to it.  When the instrument has been taken for value before it is due, the accommodation party is liable in the capacity in which he or she has signed.

An unqualified endorser is released from liability on his endorser's promise if the holder failed to make due presentment to the payor or to give the endorser prompt notice of the payor's dishonor.  The lability of a person on commercial paper may be discharged by (1) cancellation or renunciation and (2) discharge of secondary liability by changing primary contract.

An instrument is dishonored when a necessary or optional presentment is duly made and due acceptance or payment is refused or cannot be obtained within the prescribed time.

The Uniform Negotiable Instrument Act states that "where a signature is forged or made without authority of the person whose signature it purports to be, it is totally inoperative, and no right to retain the instrument, or to give a discharge, or to enforce payment thereof against any party thereto, give a discharge, or to enforce payment thereof against any party thereto, can be acquired through or under such signature, unless the party, against whom it is sought to enforce such right, is precluded from setting up the forgery or want of authority."

The act also states that "an instrument is not invalid for the reason only that it is antedated or past-dated, provided this is not done for an illegal or fraudulent purpose.  The person to whom an instrument so dated is delivered, acquired title thereto as of the date of delivery."

The act states that "where a negotiable instrument is materially altered without the assent of all parties liable thereon, it is voided except as against a party who has himself made, authorized or assented to the alteration and subsequent indorser.  But when an instrument has been materially altered and is in the hands of a holder in due course, not a party to the alteration, he may enforce payment thereon according to its original tenor."  However, any person who by his negligence substantially contributes to a material alteration of the instrument or to the making of an authorized signature is precluded from asserting the alteration or lack of authority against a holder in due course or against a drawee or other payor who pays the instrument in good faith and in accordance with the reasonable commercial standards of the drawee's or payor's business.

Banks have a debtor-creditor relationship with depositors.  Even though a depositor has funds in the bank, a payee cannot force a drawee bank to make payments.  The drawer could possibly have an action against a bank-drawee for wrongfully dishonouring a check.  Generally, banks are not obligated to pay on a check presented more than six months after date but can pay in good faith and charge the customer's account.  Banks are liable to a drawer for payment on bad checks unless the drawer was negligent.  Drawer is required to promptly examine returned checks for irregularities or be held liable for bank's losses resulting from insufficient care and vigilance.  A bank is considered to know the signature of endorsers and can collect from the party that cashed the check.  Generally, oral stop payment orders are good for 14 days; written stop payment orders are good for six months and are renewable.  A bank is entitled to a depositor's endorsement on deposited checks.  If the endorsement is missing, the bank can supply it.

Contradictions sometimes appear in negotiable instruments.  Generally the following rules apply:  words control over figures, hand-written terms control over typewritten and printed terms; typewritten terms control over printed terms; an instrument stating "I promise to pay" and signed by two persons which results in joint liability for both parties.


See any university business law textbook.
American Business Law Journal.
BROWN, G.W., and others.  Business Law with UCC Applications 1989.
Journal of Business Law.
TILLMAN, G.B., and JOUNSON K.W.  "Lender Litigation:  Variable Interest Rates and Negotiability."  American Business Law Journal, Spring, 1989.  

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