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The Law of Negotiable InstrumentsLEARNING OBJECTIVESBy the end of this chapter, you will have a basic understanding of:

o Negotiable Instruments including

o Promissory Notes

o Bills of Exchangeo Cheques

1. INTRODUCTION Most business transactions involve the exchange of goods and services formoney Payment usually either by a bank transfer or by negotiable instrument The most common negotiable instruments include cheques, bills of exchangeand promissory notes2. THE NEGOTIABLE INSTRUMENTS LAW TheNegotiable Instruments Law sets out the general rules that relate to billsof exchange, cheques and promissory notes

The rules are very similar to the United Kingdoms, Canadas, Americas,Indias & PakistansNegotiable Instruments have their origin in centuries past where they weredeveloped as an alternative to the risk of carrying gold or money from markettown to market town They represent moneys worth and are considered almost good as gold A major advantage of aNegotiable Instrumentis its transferability ANEGOTIABLE INSTRUMENTis a document that meets the requirementsfor circulation without reference to other sources. The amount must be clearly specified or capable of being calculated The Law sets forth detailed rules with 3 general types of negotiable

instruments:1. Cheques2. Bills of exchange3. Promissory Notes A cheque is a special type of a bill of exchange Much of what can be said about cheques also applies to bills of exchange A promissory note is distinct in both purpose and use from the other two Each has characteristics that make them important for the specific commercialpurpose the person who prepares the Bill is the Drawer the Drawee is the person to whom it is addressed

Once the bill is drawn, it is sent to the Drawee for acceptance who wouldwrite accepted across the face of the bill, sign and date it and return it to theDrawer. the Drawee is under no obligation to accept the bill If it is accepted, the Drawee at this point becomes theAcceptor The acceptor promises at that point to pay the bill in accordance with its terms If the Drawee refuses to accept, the bill is said to be dishonoured Demand = immediate

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Sight = within 2 business days Term = on a fixed or determined or determinable (i.e. 60 days sight) futuredate If it is a demandbill,payment must be immediate If it is a sight billit is payable at sightor within a specified number of days

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ight means acceptance Every bill is entitled to three days grace The drawer then would deposit the accepted bill just as he would a cheque At any time prior to negotiation, the drawer may transfer the bill byendorsement. This is the act of signing the bill and delivering it to the newholder the person ion possession of a bill is called a holder A holder who has paid for the bill (other than receiving it as a gift) is called aholder for value An important type of holder is a holder in due course A holder in due course is one who receives an instrument that is1. complete and regular on its face

2. before the bill is overdue3. without any knowledge that the bill had previously been dishonoured4. took the bill in good faith and for value, and5. had no notice of any defect in the title of the person who negotiated it3. BILL OF EXCHANGE TheNegotiable Instruments Law, defines a Bill of Exchange as:

o unconditional order in writing

o addressed by one person to another

o signed by the person giving it

o requiring the person to whom it is addressed to pay

o on demand or at a fixed or determinable future time

o sum certain in moneyo to or to the order of a specified person or to bearer

the person who prepares the bill is called the drawer the person to whom the bill is addressed is the drawee the drawer then sends the bill to the drawee foracceptance the bill will name a payee, who may or may not be the drawer the drawee then accepts the bill, endorses (signs) it and returns it to thedrawer the drawee (who becomes the acceptor) is under no obligation to accept a bill however, if accepted, the drawee promises to pay the bill when it comes due(it may be at a future date, say 30 or 45 days)

if the acceptor/drawee does not pay when the bill is due, he may be sued forpayment if the drawee does not accept the bill, the bill is said to be dishonoured a bill of exchange may be negotiated before its due date to other personsknown as holders a holder usually negotiates a bill by endorsement, that is placing his signatureon it the bill may be endorsement several times over as the bill changes hands

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Jack may the drawer/payee, but he owes money to Peter. Jack endorses thebill and gives it to Peter. Peter owes money to Paul, so he in turn endorses thebill, and so and so on If the bill is payable on demand or presentation or if the bill does not statea due date, it is said to be a demandbill

A demand bill does not require acceptance unless it is stated to be payable atother than the drawees place of residence or business Except for demand bills, 3 days grace is added to the payment date A sight billstate that it is payable at sight or at a specified time sight means acceptance so 3 days grace would be added Under the Bills of Exchange Act,it is not fatal that the Bill is not dated nor hasno fixed time for acceptance or if there is no mention of the amount If not dated, the bill must at least have the due date. A date may be added at alater time

a. LIABILITY OF THE PARTIES TO A BILL OF EXCHANGE Acceptance of a bill of exchange by a drawee makes the drawee liable to pay

the bill at the place and date fixed for payment, or in the case of a demand bill,at a reasonable time thereafter The bill MUST be presented by the holder or his authorized representative at areasonable hour on a business day at the place specified in the bill Once payment is made, the holder must turn the bill over to the acceptor forcancellation or destruction If a bill is dishonoured by non-payment, the holder may hold the drawer,acceptor and any endorsers liable on the bill However, in order to confirm this liability, the holder must give anopportunity to each them to pay the bill by giving each of them (except theacceptor) notice ofdishonour

To be valid, notice has to be given no later than the next business day after thedate of dishonour The notice may be either in writing or by telephone but must1. identify the bill2. indicate that the bill has been dishonoured notice of dishonour may be dispensed withthis is sometimes indicated righton the bill if the bill is a foreign bill of exchange, a formal procedure known as protest,which is done before a notary public, must be used

4. CHEQUES A cheque is a bill drawn on a bank, payable on demand. Where a cheque is delivered to a bank for deposit to the credit of a person andthe bank credits him with the amount of the cheque, the bank acquires all therights and powers of a holder in due course of the cheque. The bank is always the drawee Accepting a cheque is equivalent to extending credit since there are usuallyseveral days between handing over goods and receiving payment by cheque Often, there are another few days from the date the cheque is deposited in thebank until the time that the drawers bank takes the money out of his account

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Certification is the process whereby a bank guarantees payment of a cheque.In this case, the Bank has transferred funds out of drawers account Certification is not described in theBills of Exchange Act. It is an Americanpractice which has been adopted here in Canada An uncertified cheque is not legal tender when given as payment to a creditor

It is a condtional payment only that entitles the creditor to take action forpayment either on the debt or the cheque should the cheque be dishonoured Although not obliged to accept payment by cheque, once it has been done andthe cheque has not been dishonoured, it serves to extinguish the debt and isevidence of payment by the creditors endorsement on the back A debtor paying by cheque will often indicate the reason for payment on thecheque A cheque, being a demand payment, must be presented for payment within areasonable period of time. Most banks will not accept a cheque that is dated more than 6 months ago.Such cheques are said to be stale-dated

Stop Paymentis the process whereby the person who writes the cheque ordersthe bank not to pay the holder who presents it for paymentEndorsement in blankis when one signs a cheque without any specialinstructionsRestrictive Endorsementis where one signs a cheque for deposit only to aparticular bank accountSpecial Endorsementis where one signs a cheque and makes it payable to aspecific personEndorsement without recoursepermits only the named endorsee to negotiatethe cheque. If however the cheque is dishonoured, the endorsee cannotproceed against the endorserhe can only proceed to collect from the drawer5

. PROMISSORY NOTES TheBills of Exchange Act, defines aPromissory Note as

o unconditional promise in writing

o made by one person to another person

o signed by the maker

o engaging to pay

o on demand or at a fixed or determinable future time

o sum certain in money

o To or to the order of

o a specified person or to bearer.

Apromissory note is signed by a makerand must contain a promise to pay a

sum certain in money A promissory note may be made by two or more makers, and they may beliable thereon jointly, or jointly and severally, according to its tenor Where a note bears the words I promise to pay and is signed by two or morepersons, it is deemed to be their joint and several note Place of payment is normally specified in the promissory note Payment must take place there if the holder of the note wishes to hold anyendorser liable

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Endorsers of promissory notes are in much the same position as endorsers ofbills of exchange The maker of a promissory note, promises, by signing it, that he will make thepayment according to the terms of the note A maker is not allowed to deny to a holder in due course the existence of the

payee and the payees capacity to endorse If there has been default, a holder is obliged to give notice of dishonour to allendorsers if the holder wishes to hold them liable Not all promissory notes are on demand or for one lump sum Many promissory notes are payable over time in monthly or other periodicinstallments Installment notes are frequently used for consumer purchasers of goods suchas automobiles or boats The seller may also take a collateral security interest in the property sold The note may provide that the seller reserves title in the goods until such timeas the note is paid for

The cost for paying for the goods is spread out over a period of time with ablended payment of interest and principal The advantage to the seller is that a promissory note is a negotiable instrumentwhich he may endorse over to or in favour of the bank which will pay theseller The bank will then collect from the maker of the note An installment note will usually provide that each installment is a separatenote for payment purposes If default should occur, the whole balance owing under the note becomes dueand payable This is known as an acceleration clause

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ometimes several copies of a note will be made. If the duplicates areintended to be copies, the word copy should be stamped or written on it. Otherwise, each note is a negotiable instrument that may be sued uponLearning Goals Review The Negotiable Instruments Lawis a law that governs cheques, bills ofexchange and promissory notes Negotiable instruments are promises to pay and are not legal tender A bill of exchange facilitates commercial transactions by allowing theholder to negotiate the bill to a bank for immediate payment. A cheque is a special type of bill of exchange where the drawee isalways a bank A promissory note is a promise to pay, in writing. It may provide forpayments over time Endorsement of a cheque (or a bill) renders the endorser liable to pay ofthe bill or cheque is dishonoured On dishonour, the holder of the bill of exchange must immediately notifyall endorser of the bill (and the drawer)6. DEFENCES TO CLAIMS FOR PAYMENT OF BILLS OF EXCHANGE The holder of a negotiable instrument, whether it is a bill of exchange, cheque

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or promissory note is entitled to present the instrument for payment on its duedate If an instrument has two or more endorsers, each endorsement is deemed tohave been made in the order in which it appears on the instrument Liability to some extent follows the order of endorsement

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ot every holder receives payment A holder has greater rights than as assignee of a contract In the case of an assignment, the assigned takes subject to any defects that theremay be A holder, without notice of any prior defect of title, may enforce the negotiableinstrument against all prior parties in spite of any fraud, undue influence or setoff that may have existed between the original parties The only exception may be where one of the prior endorsers or the payee canestablish that the instrument was unenforceable due to a serious defect such as aforgery or the minority status of the maker There are 3 classes of defence that can raised to a payment of a bill of exchange:

1. real defences2. defect of title defences3. personal defencesReal Defences The most effective defences are called real defences Real defences go to the root of the instrument and are valid against all holders,includinga holder in due course

Forgery Where the signature of any party to a bill of exchange is forged, the holdermay not enforce payment against any party whose signature was forged unlessprevented from doing so either by conduct or negligence

Incapacity of a Minor A minor cannot incur liability on a negotiable instrument

Lack of Delivery of a Complete Instrument An incomplete negotiable instrument, such as a cheque, but that is notdelivered; this lack of delivery may be a real defence if someone else shouldcomplete the instrument and negotiate it or present it for paymentMaterial Alteration of the Instrument This defence limited to changes made to the negotiable instrument and doesnot affect the enforcement of the instrument in accordance with its terms Where the instrument such as a cheque is altered, the holder may only beentitle to enforce it against the maker/drawer for the original amountFraud as to the Nature of the Instrument Fraud as to the Nature of the Instrument is a rare defence It is only limited to those case where non est factum may be raised as adefence The person signing has a duty of care to all others who may receive thenegotiable instrument It is only available as a defence to someone who signed an instrument and didnot understand the nature of it due to infirmity, advance age or illiteracy

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Cancellation of the Instrument The cancellation of the instrument, such as marking Paid in Full would be adefence for claim for a claim for payment made by a holder If paid before the due date, the careless handling of the note that allows it tofall into the wrong hands, would not afford the maker or drawer of the

instrument the opportunity to avail themselves of this defence Sometimes several copies of a note or a bill will be made. If the duplicatesare intended to be copies, the word copy should be stamped or written on it. Otherwise, each note or bill is a negotiable instrument that may be sued uponDefect of Title Defences Defect of Title defences are good against all parties except a holder in duecourse A Defect of Title defence may arise where a negotiable instrument isobtained by fraud, duress or undue influence or by a promise not to negotiatethe instrument until after maturity Fraud may be a serious enough defence to constitute non est factum

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here a person has been induced to sign a cheque on the basis of falserepresentations made by the payee, the defence of fraud may be raised The defence may also arise where there has a total failure of consideration orwhere the instrument is illegal A Defect of Title defence may also be raised where a person is given theresponsibility to fill in the blanks on a negotiable instrument and that personfills in the blanks incorrectly or releases the instrument when instructed not todo so The defence also arises where a properly completed note or bill is stolen incompleted form the absence of delivery would constitute a good defect of titledefence against a holder, but not a holder in due course

Personal Defences A personal defence is a defence that is only effective as against an immediateparty. Set-off is the most common defence raised. That is the party claiming the setoffis alleging that the plaintiff owes the defendant money as well

Learning Goals Review There are 3 defences that can raised to a payment of a bill ofexchange:1. real defences2. defect of title defences3. personal defences Real defences are good against all parties including a holder in duecourse Defect of Title defences are good against all parties except a holder indue course Personal defences are good only against the immediate parties whenthe bill is presentedSUMMARY

Negotiable instruments in the form of bills of exchange, promissory notes

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and cheques are governed by the Negotiable Instruments Law Each of these instruments was developed to meet the particular needs ofmerchants To be negotiable, an instrument must possess certain essential elementsfor negotiability

The instrument must be an unconditional order in writing, addressed byone person to another, signed by the person giving it, requiring the personto whom it is addressed to pay, on demand or at a fixed or determinablefuture time a sum certain in money to or to the order of a specified personor to bearer or to a specific person If it meets these requirements, it may be negotiated by the holder to anyother by way of delivery The endorsement renders the person making the endorsement liable tothe holder in the event that the instrument is subsequently dishonoured A holder acquires greater rights under a negotiable instrument than anordinary assignee of a contractual right

A holder in due course is generally entitled to claim payment even if thereis a defect in title in the instrument The only defence against a holder in due course are what are called realdefences such as forgery, incapacity of a minor and others that mayrender the instrument a nullityKEY WORDS

ACCELERATION CLAUSE a clause in an installment note that requirespayment of the entire balance if default occurs in the payment of an installment

ACCEPTANCE-- once the bill is drawn, it is sent to the Drawee for acceptancewho would write accepted across the face of the bill, sign and date it and returnit to the drawer (the person it is paying)

ACCEPTOR --If a bill of exchange is accepted, the Drawee at this point becomesthe acceptor. The acceptor promises at that point to pay the bill in accordancewith its termsBEARER CHEQUEcheque made out to whomever is in procession of it (madeout to cash/ bearer)BILL OF EXCHANGE is an unconditional order in writing, addressed by oneperson to another, signed by the person giving it, requiring the person to whom itis addressed to pay, on demand or at a fixed or determinable future time a sumcertain in money to or to the order of a specified person or to bearer or to aspecific personCERTIFICATION (on a cheque)--is understanding by a bank to pay the amountupon presentationCHEQUE a bill of exchange, drawn on a banking institution which is payableon demand.DISHONOUR, the holder of the bill of exchange must immediately notify allendorser of the bill (and the drawer)DRAWEE is the person to whom a bill of exchange is addressedDRAWER --the person who prepares the Bill of ExchangeDEMAND BILL a bill of exchange payable on demand

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ENDORSEErecipient of a negotiable instrument who becomes the holderENDORSEMENTthe act of making your mark on the back of a cheque for thepurpose of negotiationENDORSEMENT WITHOUT RECOURSEan endorsement that may limit theliability of the endorser

ENDORSER-- holder of a cheque who transfers ownership to another by signingthe back of the chequeENDORSEMENT OF A CHEQUE (or a bill) renders the endorser liable to pay ofthe bill or cheque is dishonouredHOLDERperson in possession of a negotiable instrumentHOLDER IN DUE COURSEa person who acquires a negotiable instrumentbefore its due date that is complete and regular on its face, who gave value forthe instrument without any knowledge of default or defect in the title of priorholdersHOLDER FOR VALUEa holder who was given value for a negotiableinstrument

INSTALLMENT NOTEa promissory note repayable by a number of paymentsMAKERa person who signs a promissory noteNEGOTIABLE INSTRUMENTS are promises to pay and are not legal tenderNOTICE OF DISHONOUR notice to all parties that a bill of exchange has beendishonoured by non-paymentPAYEE-- the person entitled to payment of a negotiable instrument (person,corporation)PROMISSORY NOTE is a promise to pay, in writing. It may provide forpayments over timeRESTRICTIVE ENDORSEMENT is where one signs a cheque for deposit only toa particular bank accountSET-OFF is the most common defence raised. That is the party claiming the setoffis alleging that the plaintiff owes the defendant money as wellSIGHT BILL a bill of exchange payable three days after acceptanceSPECIAL ENDORSEMENT is where one signs a cheque and makes it payableQUESTIONS

1. What is a promissory note?2. What does sight mean?3. How many days grace is one entitled to when presenting a bill of exchange?4. Who is the payee?5. What is a maker?6. Can 16 year old Jacques be a maker of a promissory note?7. What are 3 classes of defences to a claim for payment on a negotiable instrument?8. What is the difference between a real defence and a defect of title defence?9. OldMrs. Pyl was 79 years old and living in a retirement home. She received anotice in the mail that she had won a prize. She called the number stated in theletter. A nice young man named Christopher made an appointment to see her todeliver the prize to her personally the very next day. While he was there, hedemonstrated the wonderful new vacuums that he happened to sell. Boy, couldthat thing suck! Mrs. Pyl was very impressed. However, the young man told Mrs.

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Pyl that in order to receive her prize (which were a few tea towels and an ashtray),she had to buy the vacuum for $1,800. She willingly wrote out a cheque. Whenher daughter came to visit her later that afternoon, Mrs. Pyl proudly displayed hernew acquisitions. Her daughter became very upset. What can be done now?10. Describe the document, sometimes referred to as a bill of exchange that is the

instrument normally used in international commerce for payment.a. Bill of lading is a document in which one party, the Drawer directs anotherparty, the Drawee to make a payment.b. Bill of exchange which is a document in which one party, the Drawerdirects another party, the Drawee to make a payment.c. Stamp of credit worthiness is a document in which one party, the Drawerdirects another party, the Drawee to make a payment.d. Open note issued by the Importers Bank.11. Define a bill of exchange?a. A bill of exchange is an unconditional order in writing, signed by theexporter and drawn on the importer demanding payment of the indicated

sum of money on a specified date.b. A bill of exchange is a conditional order in writing, signed by the exporterand drawn on the importer demanding payment of the indicated sum ofmoney on a specified date.c. A bill of exchange is an unconditional sales contract in writing, signed bythe exporter and addresses to the importer demanding payment againstdelivery of the goods.d. A bill of exchange is a conditional order in writing, signed by the exporterand drawn on the importer demanding payment of the indicated sum ofmoney on a date to be specified later.12. Jane Harris signs a cheque on her account at the Bank ofNova Scotia to MichaelKing. Which of the following is true?a. The Bank ofNova Scotia is the drawer.b. Jane Harris is the drawer.c. The Bank ofNova Scotia is the Drawee.d. both A and Be. both B and C13. Which of the following is an example of a negotiable instrument?a. Promissory noteb. chequec. a mortgaged. a and be. all of the above14. Lou Gaudette writes a cheque to Judy Atkinson for services rendered. What isLou called in relation to the cheque?a. Payeeb. endorserc. holder in due coursed. drawere. payor

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TRUE/FALSE15. Few business transactions involve the exchange of good and services for money.16. Negotiable instrument is not a viable method of payment in Canada.17. A cheque is a special type of bill of exchange.18. The drawee is obligated to accept a bill.

19. A minor cannot incur liability on a negotiable instrument.20. The most effective defenses are real defenses.21. Absence of consideration may be a personal defense.FILL IN THE BLANKS22.A ________________ is a defense that is only effective against an immediateparty.23.A major advantage of a bill of exchange is ___________________.24.A___________________ is a document that meets the requirements forcirculation without reference to other sources.25.The person who prepares a bill of exchange is the ______________.26. ___________________ is the process whereby the person who writes a cheque

orders the bank not to pay the holder who presents it.27.An advantage of a bill of exchange is its ________________.28. A person in possession of a negotiable instrument is sometimes called a (the)_____________.29. A(n) _______________ is a bill of exchange that is payable on demand

ANSWERS1. A Promissory Note is a promise to pay, in writing. It may provide forpayments over time.2. Sight means payable within 3 days3. 34. A Payee is the person to whom a bill of exchange must be paid to.5. A maker is a person who prepares and signs a promissory note.6. No. Jacques is incapacitated by his minority.7. Real defences, Personal Defences and Defect of Title Defences.8. Real defences are good against all parties including a holder in due course.Defect of title defences are good against all parties except a holder in duecourse.9. Mrs. Pyl may be able to claim fraud as to the nature of the instrument, a realdefence which is valid as against a holder in due course. However, it is morelikely that she will claim that she was induced to sign the cheque on the basisof false representations by Christopher. This is a Defect of Title defence. Thisdefence will not apply if Christopher negotiated the cheque to a holder in duecourse. Mrs. Pyl should also consider putting a stop payment on the chequeimmediately.10.b11.a12. c The bank is always the drawee on a cheque.13.d14.dTRUE/FALSE

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15.F16.F17.T18. T But if he does not accept, he is said to have dishonoured the bill.19. T A minor does not have the legal capacity.

20. T Real defences are available against all holders including a holder in duecourse.21.TFILL IN THE BLANKS22. personal defense23. It is transferable24. Negotiable instrument25. Drawer26. Stop payment27. Promissory28. Holder

29. cheque