Negotiable Instruments

General

Negotiable instruments are a special category of freely transferrable obligations. Cheques, bills of exchange and promissory notes are negotiable instruments. However, negotiable instruments embrace a wider category of obligations. They include banknotes, bearer shares, bonds and debentures. Some other instruments have similar characteristics such as bills of lading and postal orders.

A negotiable instrument can be transferred (assigned) by one holder to another, without giving notice to the party with the obligation to pay. They are transferred with little or minimal formality. They may be transferred by delivery or by delivery and endorsement. A transferee of a negotiable instrument will generally acquire obtain good title, even if the transferor’s title is flawed.  He may obtain a better title to it than the transferor. He can enforce it in his own name, without having to make his predecessor, party to the legal proceedings.

The significance of a negotiable instrument may be seen in the contrast between it and other assignable obligations. A person can assign the benefit of the payment receivable by him from the other party to the contract, to a third party. However, notice to the party with the obligation is required. There is also the risk that the transferee may not receive payment if the other party to the contract, claims that the payment is not due, on the basis, for example of a defect in the work or service provided by the transferee.

Where he has given a promissory note, bill of exchange or cheque, the debtor cannot raise claims on the underlying contract.  This is because the negotiable instrument is an unconditional obligation.  If there is a complaint relating to the quality of the work or even the validity of the underlying contract, this would have to be the subject of separate proceedings

Bills of Exchange

A Bill of Exchange is a negotiable instrument. Once it satisfies certain conditions, it enjoys certain statutory advantages and characteristics. A cheque is one type of bill of exchange drawn on a bank. However,  Bills of exchange embrace a wider category of instruments.

A bill of exchange must be an unconditional order in writing, addressed by one person to another, signed by the maker promising to make payment. It must be payable on demand or on a definite date.  It can be for a fixed or ascertainable sum.  It can be made payable to a particular person or to his order (assignee) or to the bearer, who has physical custody of it.

A promissory note is a simple bill of exchange by which the promisee promises to pay a certain amount on a fixed date.  This is a two-party bill of exchange.  It can be endorsed in the same way as any other bill of exchange.  The promissor is unconditionally liable.  He cannot challenge the promissory note or countermand it by reference to the underlying transaction.

It is an unconditional obligation in writing, by the debtor to the creditor to pay a fixed or ascertainable sum on a fixed or ascertainable date. The creditor may draw the bill, for acceptance by the debtor. In this case, the debtor is the drawee and the creditor is the drawer. Upon acceptance, the bill is binding on the debtor. It is unconditionally due on the due date for payment.

A bill of exchange is most commonly a three-party negotiable instrument, made and signed by a debtor to a creditor, signed by the debtor, directing the third party to whom it is addressed, to pay on demand a fixed sum or determinable sum at a certain date.  The obligation becomes binding on the third party by its acceptance or payment.

A bill payable to a bearer must be specifically expressed to be so payable.  It will also arise where it is endorsed in blank. Strictly speaking, a cheque payable to cash is not a cheque or a bill. There is no named payee as the statutory definition requires. It is effectively a mandate to pay.  Similarly, a cheque payable in blank is not technically a bill of exchange because there is no payee.  It may be interpreted that the holder has authority to pay it to be order of the drawee.

Cheques

A cheque is a three party bill of exchange, where the third party is a bank. Unlike other bills, it is presented for payment and not for acceptance. The drawer in this context may be the debtor who writes the cheque. The bank is the drawee. The bank has no obligation to the payee on the cheque, unless some guarantee is given to the payee (e.g. by a cheque guarantee card arrangement).

If the cheque is not honoured, the payee’s claim is against the drawer on the cheque. This is a separate unconditional obligation on the cheque itself and is separate to a claim on the underlying debt, The bank will usually have an obligation to the drawer to honour cheques, provided that the account is in funds or within the limits of an overdraft facility.

The payee is named on the cheque. He may be referred to by name or as bearer.

Trade Finance

Bills of exchange are commonly used in international trade. They are usually drawn on and accepted by foreign banks or another creditworthy party, rather than the trader. There are international conventions and rules worldwide relating to bills of exchange and trade credits.  See the separate section on international trade finance.

An important feature is that a Bill accepted by a bank or finance house, has a value in that it is guaranteed by a creditworthy entity. The bank may commit to accept bills in accordance with the terms of a facility. A further advantage of a bill that has been accepted by a creditworthy entity can be discounted, to permit realisation in cash before the due date and assist the cash flow cycle.

Once the creditor holds a negotiable instrument, he could in principle sell it to a third-party bank or finance house at a discount, thereby receiving immediate payment (and aiding cash flow).  The bank or finance house then pays collects the monies concerned when the bill falls due.