Summary
Highlights
A negotiable instrument is a contract for the payment of money that can be transferred by negotiation. Negotiation is the transfer of an instrument from one person to another in a way that makes the transferee a holder. This differs from assignment, where the assignee has no better rights than the assignor and is subject to prior defenses, whereas a holder in due course of a negotiable instrument takes it free from personal defenses.
Negotiable instruments serve several functions: they act as a substitute for money, facilitating transactions without the need for cash; they are a purchasing medium for goods and services; they serve as a medium of credit in business; they aid in the creation of credit; and they act as proof of a debt. They provide peace of mind in business, as they are generally accepted as cash, for example, checks.
Two primary characteristics define a negotiable instrument: negotiability, which allows a holder in due course to take the instrument free from certain defenses; and accumulation of liabilities, meaning as the instrument passes from person to person, each endorser adds their liability. To determine if an instrument is negotiable, it must comply with Section 1 of the Negotiable Instruments Law, requiring it to be in writing, signed by the maker or drawer, containing an unconditional promise or order to pay a sum certain in money, payable on demand or at a fixed time, and payable to order or bearer. If addressed to a drawee, the drawee must be named or otherwise indicated with reasonable certainty.
There are three types: promissory notes, bills of exchange, and checks. A promissory note is an unconditional promise in writing made by one person (the maker) to another, signed by the maker, engaging to pay a sum certain in money on demand or at a fixed future time to order or bearer. The maker is primarily liable, meaning they absolutely promise to pay.
A bill of exchange is an unconditional order in writing addressed by one person (the drawer) to another (the drawee), signed by the drawer, requiring the drawee to pay a sum certain in money on demand or at a fixed future time to order or bearer. The drawer's liability is secondary and conditional, meaning they are liable to the holder or subsequent endorser if the drawee does not pay. The drawee is not liable until they accept the bill, becoming an acceptor and primarily liable.
A check is a specific type of bill of exchange, drawn on a bank, payable on demand. A key difference from other bills of exchange is that the drawee must be a bank. A bill of exchange may be treated as a promissory note in certain circumstances, such as when the drawer and drawee are the same person, the drawee is a fictitious person, or the drawee lacks the capacity to contract. In these cases, the drawer may be held primarily liable, similar to a maker of a promissory note.
Other parties include the general endorser, who, by endorsing an instrument, transfers their rights and assumes certain contingent liabilities, including a warranty that the instrument is genuine and that all prior parties had capacity to contract. A qualified endorser, however, can limit their liability. An irregular endorser is a person not otherwise a party to the instrument who signs it in blank before delivery. An accommodation party is one who signs an instrument as a maker, drawer, acceptor, or endorser without receiving value for it, to lend their name to another party. They are liable to a holder for value even if the holder knew them to be an accommodation party, and can seek reimbursement from the accommodated party.