1. Characteristics of Negotiable Instruments
2. Common Negotiable Instruments

What is negotiable instrument? This term refers to any promise or order to pay that serves as a substitute for money, including but not limited to checks, bearer bonds, drafts, certain CDs, bank notes, and promissory notes.

Characteristics of Negotiable Instruments

All negotiable instruments have three main characteristics:

  • Property or assets that are transferred from one person to another when the instrument is delivered or endorsed
  • Acceptance of the instrument in good faith and the ability to file suit if it is not honored
  • The liable party does not need to be notified about the transfer

Notes and drafts, including certificates of deposit (CDs) are used in business to secure and distribute loans and the movement of goods through financing. Negotiable instruments must adhere to Article 3 of the Uniform Commercial Code (UCC) and must not include fund transfers, investment securities, or money.

Most cases are subject to the rule of derivative title, which means a property owner cannot transfer rights in a larger piece of property. This rule is suspended when it comes to negotiable instruments. The person who endorses the instruments certifies that he or she has good title or represents another person with good title and that the transfer is rightful overall. 

Negotiable instruments are transferable, meaning that the person who holds them can either exchange them for cash or transfer them to someone else. The value must be stated on the instrument. The person who receives an instrument in a transfer holds legal title to its entire value.

A valid negotiable instrument must:

  • Exist in a written document that is signed by the drawee or maker
  • Contain an unconditional order or promise to pay a certain amount of money with no other promises attached unless the additional conditions are authorized by the UCC
  • Be payable at a definite time or on demand
  • Be payment to bearer or to order

If a negotiable instrument is refused when it is presented, it is considered dishonored.

Some negotiable instruments do not need to be endorsed, while others can be endorsed using several methods. Bearer instruments just need to be delivered and don't need endorsement. They may list the person's name or have a blank endorsement. Order instruments must be signed by the payee before they are delivered to the payer.

Qualified endorsements are those that must be endorsed by a specific payee. These endorsements include an implied warranty. If an unqualified endorser receives consideration or payment, the warranty is implied to all subsequent holders. The unqualified endorser is stating that he or she has or is representing a person who has good title; that all signatures are authorized or genuine; that the instrument has not been altered in any material way; that no defense of a prior party can be used against the endorser; and that he or she has no knowledge of insolvency.

Forged negotiable instruments are invalid. Past-dated negotiable instruments are valid as long as the antiquated date was not included for a fraudulent or illegal purpose.

Common Negotiable Instruments

Perhaps the most common negotiable instrument is the check, which is a draft in a specific amount that will be honored by the payer's bank or financial institution. Money orders are similar to checks and are often purchased from the bank by the payer. The recipient can then exchange it for cash at the issuing bank.

Another example is the traveler's check, which is signed by the payer when it is issued and again when it is given to another as a form of payment. This provides an additional level of fraud protection when traveling in a foreign country.

A promissory note is a negotiable instrument in which one party promises to pay a certain amount to another party to settle an outstanding debt.

A bill of exchange is a negotiable instrument between three parties:

  • The drawer, who drafts the bill
  • The drawee, who is responsible for making payments on the bill
  • The payee, who receives payment

A check is actually a type of bill of exchange in which the bank is the drawee, the person who writes the check is the drawer, and the person who receives and cashes the check is the payee. 

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