What is negotiable instrument? How to use a negotiable instrument with example

Negotiable Instruments: Understanding and Usage

What is negotiable instrument? How to use a negotiable instrument with example in 1500 words.

A negotiable instrument is a document that guarantees the payment of a specific amount of money to a designated person or entity. It is a written instrument that represents a legally enforceable promise or order to pay a certain sum of money. Negotiable instruments are commonly used in commercial transactions to facilitate the exchange of goods and services for payment.

There are three main types of negotiable instruments: 

promissory notes, bills of exchange, and checks. Each type serves a specific purpose and has its own set of rules and characteristics. Let's explore each type in detail and provide examples to illustrate their usage.

Promissory Notes:

A promissory note is a written promise made by one party (the maker) to pay a specific amount of money to another party (the payee) at a predetermined time or on demand. It involves a two-party transaction, where the maker acknowledges the debt and promises to repay it. Promissory notes are often used in lending and borrowing arrangements.

Example: John lends $5,000 to Sarah and takes a promissory note from her, stating that she will repay the amount with interest within six months.

Bills of Exchange:

A bill of exchange is an unconditional written order by one party (the drawer) to another party (the drawee) to pay a specified amount of money to a third party (the payee) on a predetermined date. It involves three parties and is commonly used in trade transactions. The drawer is the one who initiates the bill, the drawee is the party on whom the bill is drawn, and the payee is the party who will receive the payment.

Example: Company A orders goods from Company B and issues a bill of exchange, instructing Company B to pay $10,000 to Company C, the supplier of the goods, on a specific date.

Checks:

A check is a negotiable instrument drawn on a bank by an account holder, instructing the bank to pay a specific amount of money to the person or entity named on the check (the payee). Checks are widely used for various transactions, including payment of bills, salaries, and purchases.

Example: Mark writes a check for $500 to pay his monthly rent to the landlord. The check is made payable to the landlord and includes all necessary information, such as the account number, date, and signature.

Now that we understand the types of negotiable instruments, let's delve into how to use them effectively:

Creation: To create a negotiable instrument, it must meet certain requirements. It should be in writing, signed by the person creating it (such as the maker or the drawer), contain an unconditional promise or order to pay, specify a fixed amount of money, and be payable on demand or at a specific time.

Negotiation: Negotiation refers to the transfer of ownership of a negotiable instrument from one person to another. Negotiation can occur by either delivery (handing over the physical instrument) or endorsement (signing on the back of the instrument). The endorsement may be either blank (simply signing the instrument) or special (specifying the new payee).

Example: John endorses the promissory note he received from Sarah by signing on the back and handing it over to his creditor, Mark. Now, Mark becomes the new holder of the promissory note.

Holder in Due Course: 

A holder in due course is a person who acquires a negotiable instrument in good faith, for value, without notice of any defects or claims against it. The holder in due course enjoys certain legal privileges, such as protection against certain defenses that the debtor could raise.

Example: Company C, the supplier in the bill of exchange example, sells the bill to a financial institution. If the financial institution meets the requirements of a holder in due course, it can enforce the payment from Company B, the drawee, even if Company B had a dispute with Company A, the drawer.

Discharge: A negotiable instrument can be discharged when the payment obligation is fulfilled, or it can be canceled through other means such as cancellation, surrender, or by agreement between the parties involved.

Example: Sarah repays the promissory note to Mark as per the agreed terms. Mark then cancels the promissory note, signifying its discharge.

Rights and Liabilities: Various rights and liabilities are associated with negotiable instruments. For example, the holder of a negotiable instrument has the right to sue the parties involved for non-payment. The parties to a negotiable instrument may also have warranties and obligations, such as the warranty of payment, warranty of title, and obligation to notify any defects or claims.

Example: If a check bounces due to insufficient funds in the drawer's account, the holder of the check can sue the drawer for non-payment. The drawer may be held liable for damages caused by dishonoring the check.

In conclusion, negotiable instruments play a crucial role in facilitating commercial transactions. Promissory notes, bills of exchange, and checks are commonly used examples of negotiable instruments. By understanding their characteristics and following the legal requirements, parties can create, negotiate, and enforce these instruments to ensure secure and reliable payment methods in various business contexts.