Negotiable Instruments

Types of Negotiable Instruments

There are four types of negotiable instruments: drafts, checks, notes, and certificates of deposit. Drafts and checks fall under a classification as "promises to pay". A promissory note is a written promise made by one person (the maker) to another (usually the payee) payable either on demand or at a definite time. A certificate of deposit (CD) is a type of note issued when a party deposits money with a bank, with the bank promising to repay the money, with interest, on a certain date.

Requirements of Negotiability

Before an instrument can be negotiated, it must meet the following requirements:

1) Be in writing.

2) Be signed by the maker or the drawer.

3) Be an unconditional promise or order to pay.

4) State a fixed amount of money.

5) Be payable on demand or at a definite time.

6) Be payable to order or to bearer, unless it is a check.

Liability Associated with Negotiable Instruments

There are two kinds of liability associated with negotiable instruments - signature liability and warranty liability. Those who sign negotiable instruments are potentially liable for payment of the amount stated on the instrument. Makers and acceptors (drawees that promise to pay an instrument when it is presented for payment at a later time) are primarily liable. Drawers and endorsers are secondarily liable only if the instrument is properly and timely presented, the instrument is dishonored, and timely notice of dishonor is given to the secondarily liable party.

Warranty liability extends to both signers and nonsigners. It falls into two categories- transfer of liability and presentment liability. One who transfers an instrument for consideration makes the following warranties to all subsequent transferees and holders who take the instrument in good faith:

1) The transferor is entitled to enforce the instrument.

2) All signatures are authentic and authorized.

3) The instrument has not been altered.

4) The instrument is not subject to a defense or claim of any party that can be asserted against the transferor.

5) The transferor has no knowledge of any insolvency proceedings against the maker, the acceptor, or the drawer of the instrument.

A person who presents an instrument for payment or acceptance makes the following presentment warranties to any other person who in good faith pays or accepts the instrument.

1) The person obtaining payment or acceptance is entitled to enforce the instrument or is authorized to obtain payment or acceptance on behalf of a person who is entitled to enforce the instrument (there are no missing or unauthorized endorsements).

2) The instrument has not been altered.

3) The person obtaining payment or acceptance has no knowledge that the signature of the drawer of the instrument is unauthorized.

It is through negotiable instruments that the world's daily business is transacted. Any business person must be familiar with the basic types of negotiable instruments, their proper transfer, the responsibilities of the parties to such instruments, and factors that may affect their value.

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