Negotiable instruments – Definition and analysis

Negotiable instruments have been around for centuries. They are still used today in domestic or international trade all around the world. It is therefore interesting to take a closer look at them. This article contains in the following topics (Click on the link to go directly to the subject you are mostly interested in):

What are Negotiable instruments?

“Negotiable instruments” consists of two words: the noun Instruments and the adjective Negotiable.

Let’s consider the noun first. Instruments refer to payment, credit or financial instruments. In fact, depending on how they are used, negotiable instruments can be considered as payment instruments, as financial instruments or as credit instruments.

The concept of payment instruments has been analyzed deeply in a previous article. Payment instruments facilitate payments and make fund transfers easy between the end parties involved. The main purpose is paying or getting paid with monetary value. On the other hand, Financial instruments are assets that can be traded. Financial instruments are usually paper or electronic documents representing a legal agreement involving a monetary value. Finally credit instruments are simply documents which make credit transactions possible. Banks grant credit to people and businesses on the basis of credit instruments that they possess.

The other word is the adjective negotiable. It originates from the French Word “negoce” which means “business, trade or management of affairs”. Something that is negotiable is something that can be traded or exchanged in good faith and for value, so with “full confidence”. Trust has been qualified as the most powerful currency in business. A Law dictionary defines as negotiable something which is legally capable of being transferred by endorsement or delivery.

So simply put, negotiable instruments can be seen as credit, financial or payment instruments that can be legally transferred by endorsement or delivery. Negotiable instruments are also referred to as commercial papers.

Instruments that cannot be legally transferred are non-negotiable. The picture below shows how instruments are classified in the most of the countries and provide few examples of the types of instruments.

Classification of Negotiable and Non Negotiable Instruments

Classification of Negotiable and Non Negotiable Instruments

Now we will consider key characteristics of negotiable instruments.

Characteristics of Negotiable Instruments

To be valid, a negotiable instrument must meet the following requirements:

  • It must be a written document: All negotiable instruments must be in writing. The document can be printed, handwritten, engraved, typed etc.
  • It must be an unconditional promise to pay a stated fixed amount of money: the party who makes the promise must perform that promise even though the other party has not performed according to the (commercial) agreement. It is also referred to as independent promise. The name of the person who is to make payment must be clearly featured on the document.
  • It must be payable to order or to bearer: negotiable instruments may state a payee or not. When a negotiable instrument features the name of the payee, it is payable only to order of that payee. Otherwise anyone in its possession (the bearer) can become the payee.
  • It must be payable on demand or at a definite time: It is also said that the time of payment must be certain. If the order is to pay when convenient then such an order is not a negotiable instrument. When negotiable instruments are payable on demand, they usualy contain the statement “payable on demand or at sight” or they do not state any time of payment at all. When they are payable at a definite time, you usually find mentions like “payable after x days or months” or “payable x days or months after sight/date”. After sight/date means after the day on which the instrument is dated, or presented for acceptance or sight.
  • It must be signed by the maker or the drawer: The signature is the formal proof, the binding force of the instrument. By signing, the maker or the drawer agrees with the content of the document.
  • It must be freely transferable from one party to another party: negotiable instruments are easily and freely transferable. There are no formalities or much paperwork involved in such a transfer. The ownership of an instrument can transfer simply by delivery or by a valid endorsement. And no notice of the transfer needs to be given to the party liable in the instrument.

Presentment and acceptance of Negotiable Instruments

Before negotiable instruments are accepted, they must be presented. Presentment is the demand made by or on behalf of the holder to the payor, requesting him to accept or/and pay the instrument. If a negotiable instrument is payable after sight, then presentment is necessary in order to fix its maturity, the date at which it falls due. The person making the presentment must exhibit the instrument, give reasonable identification and sign a receipt on the instrument for any payment made or surrender the instrument if full payment is made. After presentment, the instrument may be either accepted or dishonoured by non-acceptance or by non-payment. The person that accept the instrument is called the Acceptor.

A negotiable instrument is said to be accepted when the acceptor (the payer or someone representing him) writes the word “Accepted” across the document and puts its signature. But the signature is enough to make the acceptance valid.

There are two types of acceptance:

  • General Acceptance: This occurs when the payer accepts the liability on the instrument without any condition and limitation on the amount. So general acceptance is unconditional and unqualified.
  • Qualified Acceptance: When the acceptor puts some condition while accepting the instrument, the acceptance is said to be qualified. The acceptor can put only conditions that are legally allowed.

Dishonour of Negotiable Instruments

Negotiable instruments can be dishonoured by non-acceptance or by non-payment. The consequences for the holder are the same: he may not collect the payment due on the instrument. When a negotiable instrument is dishonoured, the holder may sue the prior parties i.e. the drawer and the endorsers after he has given a notice of dishonour to them. There are generally two options available for the notice of dishonour: Noting and Protest.

Noting is a minute recorded by a notary public on the dishonoured instrument or on a paper attached to such instrument. The holder takes the instrument to a notary public who presents the dishonoured instrument again to the defaulting party for acceptance or payment. In case it is not accepted again, the notary records on the instrument the reason for dishonour. Noting should take place shortly after the non-acceptance. Recommendation is to do it on the due date itself or on the next business day.

In certain cases, noting might not be enough or suitable. For instance, foreign negotiable instruments which are dishonoured in certain countries, must be protested in order for action to be taken on them. For that the holder requests the notary to draw a formal certificate attesting the dishonour of the negotiable instrument. That certificate is a seperate document called protest. Contrary to noting, protests are recognised and accepted by courts for local or foreign transactions.

In certain countries like France, noting does not exist and the holder must establish a protest.

Endorsement and negotiation of Negotiable Instruments

The endorsement of negotiable instruments consists of words qualifying that act or not, followed by the signature of the endorser. An endorsement must be written on the instrument itself or upon a paper attached thereto, called an ALLONGE.  An endorsement must be performed for the full amount of the instrument, but if the instrument has been paid in part, it can be endorsed as to the remainder.  There is no limit to the number of endorsements that may be made on a negotiable instrument. The only exception is when negotiability has been destroyed, i.e. there is a defect in the title and it cannot be traded anymore.

Endorsing negotiable instruments implies legal constraints that the endorser must comply with:

  1. The endorser must be the lawful owner of the instrument,
  2. The endorser knows of no defect in it (At least he should not be aware of any defect),
  3. The endorser has received the instrument in good faith for value received, and
  4. The endorser is legally capable of transferring it to another party.

Failure to comply with any of the above conditions makes the endorsement invalid.

After the endorsement, the endorser (also called the transferor) delivers the instrument or title to the future holder (the endorsee or transferee). This completes the negotiation of the instrument. Negotiation therefore consists of transferring the title to and rights in the instrument from one person to another so that the transferee becomes the legal holder.  Negotiable instruments payable to bearer are negotiable by delivery alone (No signature needed). But if payable to order, the instrument must be negotiated by the endorsement of the current holder completed by delivery to the future holder.

There are several types of (legal) endorsements: Blank Endorsement, Special endorsement,  Conditional endorsement, Restrictive endorsement.

  • Blank endorsement: If the endorser signs his name only without designating a payee, the endorsement is said to be in blank and it becomes payable to bearer. This is very seldom in practice since it makes the instrument enforceable by any holder.
  • Special or Full endorsement: A special endorsement is one where the endorser puts his signature and the name of a person to whom or to whose order the payment is to be made, on the instrument. It therefore limits the instrument to a particular person.
  • Conditional endorsement: Here the endorser sets one or more conditions to his or her liability on a negotiable instrument.  Conditions are usually related to the happening of specified events. However, the fulfillment of condition(s) is binding between endorser and endorsee only. The paying bank is not bound to verify their fulfillments.
  • Restrictive endorsement: It is an endorsement where the endorser restricts or prohibits further negotiation. After a restrictive endorsement, the endorsee can only get paid. He cannot endorse and deliver the instrument to another person.

Discounting of Negotiable Instruments

Discounting is the arrangement in which a bank “buys” a negotiable instrument from the payee (usually a business) for less than the value shown on it before it is due to be paid. The payee receives the amount on the negotiable instrument less administrative charges, fees and interest.

Since negotiable instruments are paid generally 30, 60 or 90 days after the issuance or acceptance, the business does not have to wait that long and can receive the funds immediately, usually in 24 hours. Discounting thus allows to improve cash flow and working capital. But there are risks associated to discounting too. If the debtor does not pay, the bank will ask the business to still honor the payment. So the business remains the payment guarantor. There are cases, where the “buyer” of negotiable instruments, collects the payments and bears the default risk. Fees associated to the discounting are then significant and may amount up to 20-40% of the instrument amount.

Types of Negotiable Instruments used in trade

There are numerous types of negotiable instruments. Theoretically we can cite all instruments that are negotiable like bank notes, bills of exchange, bearer bonds, cheques, dividend warrants, drafts, government circular notes, negotiable short-term debts, promissory notes, share warrants, some certificates of deposit, etc. The list is quite long.

In the rest of this paragraph, we will look at the ones that are commonly used in trade: Promissory Notes, Bills of Exchange and Cheques.

Promissory Notes

Promissory notes are negotiable instruments that involve two main parties: the Drawer (also called the maker, debtor or payor) and the Drawee (bearer, Creditor or Payee). The drawer makes the promissory note and promises unconditionally to the drawee a certain sum of money on a specific date. The drawee is the person in whose favor the promissory note is drawn.

In a promissory note, the payor is the one who makes the instrument. A customer for example can draw a note and direct it to a supplier, promissing to pay him a certain sum of money on a specific date. Even if promissory notes are often issued as result of a business transaction, this must not be the case. In certain countries, individuals draw promissory notes on special occasions like weddings.

Promissory notes are not presented for acceptation, since they are promises to pay issued by payors. They are just presented for payment at due date.

Two parties involved in a promissory note

Two parties involved in a promissory note

The figure above shows the two main parties to a promissory note. But we will see in future articles that drawer’s bank and drawee’s bank can play a role in the transaction too. Promissory notes are push transactions.

Bills of Exchange

Bills of exchange originated as a method of settling transactions in international trade. They are negotiable instruments that involve three parties:

  1. The Drawer: The person who makes the bill and gives the order to pay a certain sum of money
  2. The Drawee: The person who accepts the bill of exchange, or who is directed to pay a certain sum.
  3. The Payee: The person receiving payment is called the payee. He can be a designated person or the drawer himself.

The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are generally the same entity, unless the drawer transfers the bill of exchange to a third-party payee.

Contrary to promissory notes that are made by debtors, Bills of exchange are issued by the creditors. Bills of exchange must therefore be presented for acceptation. Only accepted bills of exchange are valid and the maturity date is determined after acceptation.

In business transactions, a supplier issues a bill of exchange with himself as payee and direct it to his customer for acceptance. Bills of exchange are still widely used in international trade. Bills of exchange are pull transactions.

Parties involved in a bill of exchange

Main parties involved in a bill of exchange



Cheques are negotiable instruments that are seen like another form of a bill of exchanges in many countries. Here the drawer is a bank. And such cheques are only payable on demand (so not at a specified date). They can be transferred like any negotiable instrument by endorsement and delivery.

The picture below shows how it works. The account holder requests his bank to debit his account and draw the cheque on his behalf. The bank issues the cheque and hands it over to his customer, the real drawer. The drawer delivers the cheque to the payee. And finaly the payee presents the cheque to the bank for payment.

Parties involved in a cheque

Parties involved in a cheque

Contrary to promissory notes and bills of exchange that are paid in the future, cheques are paid on demand when they are presented. Therefore cheques cannot be used as credit instruments. Cheques serve only as payment instruments.

Note however that there are many types of cheques and the most commonly used everywhere in the world are not negotiable.

Why corporations still use negotiable instruments today

If companies use negotiable instruments, it is because there are certainly some advantages attached to it. But as we will see below, there are drawbacks too. It is up to holder to decide depending on his situation what is the best usage he can make of the instrument in his possession.

Negotiable instruments are instruments of credit

To carry out a commercial transaction, the customer does not need cash immediately. He buys on credit and pays only in the future, at the maturity of the instruments. On the supplier side, cash will be available only later, but there is a possibility to get cash ealier (See below).

Negotiable instruments can be discounted

The payees do not have to wait for the due date to get the money. If they are in need of money, they can convert the negotiable instruments into cash, by discounting them with a bank. So the money does not get locked in. However, the payee does not receive the money in full since the bank takes fees.

Negotiable instruments are valid evidence of debt

They are full proof of indebtedness since they are unconditional promises to pay.  No need for the payee to prove that the debt exists. If the instrument is valid, a court will assume that the purchaser is in debt of the seller. The maker of a note or the acceptor of a bill must be careful when signing it. The holder may cash it even if there is no underlying debt since he does not have to prove it.

Negotiable instruments can be easily transferred

The bearer of a negotiable instrument can easily transfer it to another party for settlement of debts. He just needs to endorse it and deliver it to the other party.  Blank endorsement must used with extreme care since the instrument can be cashed by any bearer.

Negotiable instruments used in trade (in few countries)

The following table gives an overview of negotiable instruments used in Trade in few countries.

Topics England France India USA China
Negotiable instruments Law Bills of Exchange Act 1882 (UK) Book 5 of the commercial code Negotiable Instruments Act, 1881 Articles 3 and 4 of the Uniform Commercial Code (UCC) Negotiable Instruments Law of the People's Republic of China
Negotiable instruments commonly used in trade Bills of exchange
Promissory notes
Bills of exchange (Lettre de Change)
Promissory notes (Billet à ordre)
Bills of exchange
Promissory notes
Bills of exchange
Promissory notes
Bills of exchange
Promissory notes
Issuer Individual or Business Only Business Individual or Business Individual or Business Individual or Business
Receiver Individual or Business Only Business Individual or Business Individual or Business Individual or Business
Maturity Usually between 30 and 60 days Usually between 30 and 60 days Usually between 60 and 90 days Usually between 30 and 60 days Usually between 60 and 90 days
Days of grace (after due date) 3 days of grace permitted after the deadline. No days of grace permitted. 3 days of grace permitted after the deadline. Number of days of grace varies. No days of grace permitted.
Presentation timelines Presentment on the day it falls due if payable at sight,

Otherwise (payable on demand), it must be presented within a "reasonable" time.
Holder must present the instrument either at deadline, or within 10 days after the deadline, or within one year if the instrument is payable at sight. 1) When the time is specified, within that specified time.
2) When the time is not specified within a reasonable time.
3) When the presentment is not necessary, any time before payment
Presentment on the day it falls due if payable at sight

Otherwise (payable on demand), it must be presented within a "reasonable" time.
If payable on sight, it should be presented within one month of the date of issue;
If payable on a fixed date, it should be presented within 10 days of the date of maturity.
Validity Instrument becomes invalid after the presentation timelines above Instrument becomes invalid after the presentation timelines above Payable within one year if the instrument is payable at sight. Instrument becomes invalid after the presentation timelines above Bills or notes payable on sight become invalid two years after the date of issue.
Cheques become invalid six months after the date of issue
Remedies in case of non-payment Legal recourse possible after Noting / Protest Legal recourse possible after Protest Legal recourse possible after Noting / Protest Legal recourse possible after Noting / Protest Right of recourse against the endorsers, the issuer and other debtors of the bill after providing relevant evidence of non-acceptance or non-payment.

In the next articles, we will have a look at the promissory note and the bill of exchange.

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