Definition
A negotiable instrument refers to a legal document that guarantees the payment of a specified amount of money, either on demand, or at a set time, from the payer to the payee. The document is freely transferable, meaning it can be passed from one party to another as payment. Some common examples of negotiable instruments include checks, promissory notes, and bill of exchange.
Phonetic
The phonetic pronunciation of “Negotiable Instrument” would be: nuh-goh-shee-uh-buhl in-struh-muhnt
Key Takeaways
Negotiable Instrument Takeaways
- Negotiability: This is the cornerstone of negotiable instruments. It means that an instrument is freely transferable by delivery or by endorsement and delivery. Once an instrument is negotiated, the transferee becomes the legal owner and can sue on the instrument in their name.
- Types of Negotiable Instruments: The most common types are drafts, checks, promissory notes, and certificates of deposit. These instruments are typically part of daily transactions making payments between parties efficient and effective.
- Liability and Payment: The person to whom an instrument is negotiated can acquire better titles than the transferor. The liabilities on these instruments are derivative and conditional upon the payment of the instrument. In case the instrument is dishonored, the drawer, endorsers, and acceptor are liable to compensate the holder.
Importance
Negotiable instruments are crucial in business and finance as they represent a reliable and convenient way to transfer money and make payments, thereby facilitating trade. These instruments, like checks, promissory notes, or bills of exchange, indicate a promise or order to pay a specific amount to a named party or its bearer. As they are negotiable, they can be transferred from one person to another in good faith, making them a highly liquid asset. Since they’re easily transferable and hold a specific monetary value, they enable commercial transactions, lending, and trading activities to be conducted more seamlessly while providing a layer of financial security and trust for involved parties.
Explanation
A negotiable instrument serves as a documented promise or order for the payment of money that is unconditional and transferable. The primary purpose for using a negotiable instrument is to provide an efficient way for businesses and individuals to transform money into a portable document that offers a safe and secure way to transport, distribute, or exchange money. This facilitates smooth business transactions, as the receiver can use the negotiable instrument to cash it, deposit it into a bank account or use it as a financial instrument.Negotiable instruments, such as cheques, drafts, promissory notes, and bills of exchange, are an integral part of the financial system. The holder of a negotiable instrument can obtain the amount written on it from the payer either on demand or at a future date. Moreover, the unique attribute of negotiability, or the ability to transfer the instrument from one person to another, sets these documents apart from others. The receiver can further negotiate the instrument, thereby allowing for its circulation in the market just like money. Thus, negotiable instruments not only enable convenient and secure transactions but also contribute to the fluidity of market operations.
Examples
1. Checks: Perhaps the most common example of a negotiable instrument in business and finance is a check. A check is a written order to a bank to pay a specified amount from the account of the person or entity who has drawn the check (the drawer) to another person or entity (the payee). This also extends to cashier’s checks and bank drafts.2. Promissory Notes: A promissory note is a financial instrument that contains a written promise by the issuer or maker to pay a specific amount to a particular person or bearer. It is often used in finance for loans, personal debt, and other types of credit. 3. Bill of Exchange: Also known as a draft, a bill of exchange is a binding agreement by one party to pay a fixed amount of cash to another party at a predetermined future date or on demand. These are often used in international trade and can be sold to a third party, which is often a financial institution that will advance funds to the holder of the draft for a fee.
Frequently Asked Questions(FAQ)
What is a negotiable instrument?
A negotiable instrument is a document that guarantees the payment of a specific amount of money, either on demand or at a set time, with the payer named on the document.
What are some examples of negotiable instruments?
Examples of negotiable instruments include checks, promissory notes, bills of exchange, banknotes, and drafts.
What makes a document a ‘negotiable instrument’?
For a document to qualify as a negotiable instrument, it must meet certain requirements like being freely transferable, and the document must specify a certain amount of money payable unconditionally.
Can a negotiable instrument be transferred?
Yes, a notable aspect of negotiable instruments lies in their transferability. This means that the instrument can be transferred from one person to another by delivery or endorsement and delivery.
What happens when a negotiable instrument is endorsed?
When a negotiable instrument is endorsed, the person endorsing it guarantees that the payer will pay the specified amount on the document, or the endorser will be responsible for payment.
What is the difference between an order instrument and a bearer instrument?
An order instrument is payable to the person named on the instrument or to any person to whom it’s been endorsed. A bearer instrument is payable to anyone who presents the document for payment.
Is a credit card a negotiable instrument?
No, credit cards are not negotiable instruments because they do not promise to pay a certain amount of money. Instead, they represent a revolving credit arrangement.
What legal rules govern negotiable instruments?
In many jurisdictions, negotiable instruments are governed by the law of negotiable instruments, a branch of commercial law. In others, they are covered by the Uniform Commercial Code (UCC).
What is the advantage of using negotiable instruments?
Negotiable instruments provide a reliable way to make payments or transfer funds, especially over distances where cash payments would be inconvenient or risky. They can be easily transferred and provide a written record of the transaction.
Can a negotiable instrument be cancelled?
While a payment on a negotiable instrument can be stopped under certain circumstances, cancelling a negotiable instrument can be more complex and often requires an agreement between the parties involved.
Related Finance Terms
- Bill of Exchange
- Bank Draft
- Promissory Note
- Cheque
- Certificate of Deposit
Sources for More Information
