Chapter 14 – Negotiable Instruments
Negotiable instruments flow free of the equities and they are governed by special rules
that are intended to make the business world operate efficiently. By definition, a
negotiable instrument consists of a contract that contains an obligation to pay; it is a
contract that is intended to eventually result in the payment of money.
Many rules that normally govern contracts do not apply in the same way to negotiable
instruments, there are three important differences. Pg. 322**
1. Consideration – the requirement of consideration is more easily satisfied in the case of
2. Privity – anyone who holds a cheque can sue on it, even though they were not an
original party to the creation of that cheque.
3. Assignment – a person receives a contractual right through an assignment takes it
subject to the equities. The assignee cannot be in a better position than the assignor.
A negotiable instrument is more valuable that a simple contract because it is negotiable. It can
be easily transferred from one party to another in a way that may remove any defects. On the
down side it carries the major risk that is associated with every contract: non-performance. If a
cheque is created by a person who has no assets, it may be a worthless piece of paper. Coins
and bill however are never worthless.
Bills of Exchange Act 1890, was created with the intention was to increase economic
efficiency by providing business people with a comprehensive set of rules regarding non-
monetary payments. It contains a large number of rules that a contract must satisfy. If those
requirements are not met, the Act does not apply. If I did not participate in the creation of a
cheque I may not be willing to buy it unless I can be assured, by simply looking at that piece of
paper, that it is valuable. It applies to only three types of negotiable instruments: cheques, bills
of exchange, and promissory notes.
A negotiable instrument MUST consist of and contain the following: pg. 324**
- It must be signed and written
- Parties must be clearly identified
- The time of payment must be clearly stated
- Must contain an obligation to pay a specific sum of money
- Contain unconditional obligation to pay 1. Cheques – the most common form of negotiable instrument. It is created when a person
orders a bank to pay a specific amount of money to someone.
Parties to a cheque:
- Drawer: party who writes the cheques
- Drawee: party who is giving the money (bank)
- Payee: party who receives the money
Most cheques operate smoothly, however some are more complicated and they include: pg.
- Postdated cheques: dated after the current date and cannot be cashed until due date
- Stale dated cheques: a cheque is stale dated when the payee does not seek payment
within a reasonable time. Usually stale after six months.
- Overdrawn cheques (“NSF”): drawer’s account does not hold enough funds to satisfy
the cheque completely. Cheque may be treated as drawer’s request for loan. However
banks usually reject request and refuses payment; bank may accept request, pay, and
- Countermanded cheques (“stop payment”): drawer orders bank to refuse payment.
Bank must normally obey drawer’s instructions; bank cannot debit drawer’s account,
bank will not make payment. The bank may refuse in certain circumstances; eg
insufficient details provided on cheque to be countermanded, if honoured by mistake
bank usually has right to debit account.
- Certified cheques: bank’s promise of payment (guaranteed funds) to payee. Payee has
rights against drawer and bank; cheques as good as drawer’s and bank’s promise;
payment even if overdrawn and countermanded. Courts generally treat certification as
“something equivalent to money.”
2. Bills of Exchange – created when one person orders another person to pay a specific
amount of money to a third person. May be drawn on a bank or anyone else. Pg. 329**
a. Marissa used a basic pre-formatted bill of exchange. She ordered Red River to
pay $100,000 to Olaf six months after March 1 (so September 1).
b. Olaf could’ve kept the bill until September 1, but he wanted assurance that he
would actually receive payment then. He presented the bill to Red River on
March 15. c. Red River could either:
i. Indicated it was not prepared to pay $100,000 on September 1, in which
case it would’ve dishonoured the bill, and Olaf would’ve been entitled to
sue Marissa for immediate payment.
ii. Or Red River could’ve indicated that it was willing to honour the bill when
it came due. It would’ve have shown acceptance, similar to certification,
occurs when the drawee promises to pay a bill. At that point Red River
would become to acceptor rather than simply the drawee.
d. After acceptance, Red River can be sued by the payee if it fails to make payment
on the due date. Adding to that not only was Red River required to pay Olaf
$100,000 on September 1, but Marissa also lost the ability to cancel the bill.
Note four more important things about bills of exchange:
- A bill of exchange is not enforceable unless it is supported to consideration.
- A cheque must be payable “on demand”. The drawer must order the drawee to make
payment as soon as the payee presents the cheque. If it is payable on demand it is
called “demand draft”, if the payee is not entitled to receive any money until three days
after the bill has been presented to the drawee then it is called a “sigh draft”, and if it is
to be payable only on a future date then it is called a “time draft”.
- Also a bill of exchange is usually used for one of two purposes. First, to safely transfer
funds. Second, it can be used to easily extend credit.
3. Promissory Notes – is created when one person gives another person a written
promise to pay a specific amount of money. The person who creates the instrument is
called the “maker” and the person intended to receive the money is once again the
a. Although there may be no drawee, the bank usually written on the note is where
the payment can be received. If not bank is noted then payment may be collected
at the maker’s office or home.
b. A promissory note is almost always used as accredit instrument. Usually require
the payment of interest as well.
c. Notes are often payable in instalments. As a matter of risk management a short
receipt should be written on the note each time an instalment is paid. Without
that the maker may be forced to make the same payment twice. d. An acceleration clause is often found on a promissory note. It states that the
entire amount of a promise becomes due immediately if a single instalment is
not paid on time.
Methods of Negotiation pg. 333**
The process of negotiation depends on whether an instrument is payable to bearer or to order.
A negotiable instrument is payable to bearer if any person who holds it is entitled to receive
payment. Can arise in several ways:
- Person X could make the note payable “to person Y or bearer” or “to bearer”
- Person X could have left the name of the payee blank
- Person X could’ve made the note payable to a fictitious person or to a non-person.
A bearer instrument can be negotiated by the simple delivery, or physical transfer, of the
A negotiable instrument is payable to order if the party that is entitled to receive payment is
named. Example being payable “to Person X”.
An order instrument cannot be negotiated unless it is endorsed and delivered to a new party. If
Person X wanted to negotiate that note to his friend, he could not simply give his friend the
cheque, he would also have to endorse it by at least signing his name on the back.
Liability – see pg. 334-335 for clarity**
The primary liability under a promissory note falls on the maker, however an endorser may also
be held liable. A person who provides an endorsement promises people who later acquire the
instrument that it will be paid. As a result:
- The holder of the note may receive full payment even if the maker was unable to pay a
cent. The holder could sue everyone who endorsed the note. If another person simply
negotiates/sells the note while