PART 5 – SPECIAL CONTRACTUAL
RELATIONSHIPS

Chapter 26 – The Law
of Negotiable
Instruments
Prepared by Douglas H. Peterson, University of
Alberta
Copyright © 2004 McGraw-Hill Ryerson Limited
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THE LAW OF NEGOTIABLE INSTRUMENTS
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Introduction
Historical Development of the Law
The Bills of Exchange Act
Bills of Exchange
Liability of the Parties to a Bill of Exchange
Cheques
Promissory Notes
Defences to Claims for Payment of Bills of
Exchange
Consumer Protection and Negotiable Instruments
Copyright © 2004 McGraw-Hill Ryerson Limited
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INTRODUCTION
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Negotiable Instrument – an instrument in writing
that, when transferred in good faith and for value
iwthout notice of defects, passes good title to the
instrument to the transferee
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A document that meets the requirements for circulation
without reference to other sources
Significant role in commercial transactions and
commercial credit
Credit required in business world
Greater safety in negotiable instruments than in cash
Copyright © 2004 McGraw-Hill Ryerson Limited
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ESSENTIAL CHARACTERISTICS OF A
NEGOTIABLE INSTRUMENT
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Claim for funds against drawer of instrument
Freely transferable
May be used as credit instrument
Instruments are contracts with special rules
New party may enjoy better rights than old
Similar to an assignment but new party gets
better rights than old
Copyright © 2004 McGraw-Hill Ryerson Limited
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ESSENTIAL CHARACTERISTICS OF A
NEGOTIABLE INSTRUMENT
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Consideration – instruments has own
consideration
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Two contracts – promise supports 2 different
contracts
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Sale
Instrument
Privity of contract
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Instruments are an exception to the rule
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Anyone with instrument can sue or be sued
regardless of privity
Assignment of contract: subject to the equities
Copyright © 2004 McGraw-Hill Ryerson Limited
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HISTORICAL DEVELOPMENT
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Allowed for trade between merchants in
different places
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Connection of business merchants in different
places to provide a note or authorization
Notes became known as bills of exchange
UK codification of common law prior to 1882
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Adopted in Canada
Applies to all types of negotiable instruments
Applies federally
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THE BILLS OF EXCHANGE ACT
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Applies to bills of exchange, cheques, and
promissory notes
Mandatory rules, parties cannot agree otherwise
Advantages:
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Convenience – suitable substitute for money
Credit – can be used to create credit
Negotiability – ability to be readily transferred to another
party
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Greater rights than a normal assignment
Reduces risk
Holder of instrument may have better rights than person
received instrument from
Copyright © 2004 McGraw-Hill Ryerson Limited
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BILLS OF EXCHANGE ACT
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Types
Bill of Exchange – instrument in writing,
signed by drawer and addressed to drawee,
ordering drawee to pay a certain sum to the
payee at some fixed or determinable time, or
on demand
Promissory Note - written promise to pay a
specified sum of money to another party at a
fixed or determinable time or on demand
Cheque – Bill of Exchange drawn against a
bank and payable on demand
Copyright © 2004 McGraw-Hill Ryerson Limited
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BILLS OF EXCHANGE ACT
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Endorsement – signing of one’s name on the
back of a negotiable instrument for the
purpose of negotiating it to another
Holder – the person in possession of a
negotiable instrument
Holder in due course – a person who
acquires a negotiable instrument before its
due date that is complete and regular on its
face and who gave value for the instrument,
without any knowledge of default or defect
in the prior title holders
Copyright © 2004 McGraw-Hill Ryerson Limited
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BILLS OF EXCHANGE
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Bill of Exchange (B.O.E.)
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An order to a person to pay an amount to
another person
Drawee has no obligation to third party until bill
is accepted
Avoids having to use cash
Can be used to create creditor/debtor
relationship
Copyright © 2004 McGraw-Hill Ryerson Limited
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BILLS OF EXCHANGE
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Drawer – party who draws up the bill of
exchange
Drawee – party who is required to make
payment on the B.O.E.
Payee – party named to receive payment on
the B.O.E.
Acceptor – drawee who consents to B.O.E.
by signing it together with the word
“accepted” and the date
Copyright © 2004 McGraw-Hill Ryerson Limited
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BILLS OF EXCHANGE
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Demand draft – payable immediately upon
presentation
Sight draft – “at sight” 3 days of grace
Time draft – payable within certain
stipulated period after date stamped on
instrument
Copyright © 2004 McGraw-Hill Ryerson Limited
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LIABILITY OF PARTIES (BILL OF
EXCHANGE)
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Acceptance of a bill – renders the drawee
liable to pay the bill according to the bill
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Must be presented by holder at place specified
If payment refused holder must act quickly
Bill dishonored
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Holder can sue drawer, acceptor and endorsers
Must give notice of dishonor
Copyright © 2004 McGraw-Hill Ryerson Limited
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CHEQUES
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A bill of exchange drawn on a bank and
payable on demand
Primary purpose the exchange of funds
Issuing a Cheque
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An unconditional promise to pay the specified
sum to anyone who presents the cherub to the
bank for payment
Holder – a person who presents a negotiable
instrument for payment
Copyright © 2004 McGraw-Hill Ryerson Limited
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CHEQUES
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Delay
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Accepting a cherub is equivalent to extending credit
since there are several days between handing over
goods and receiving payment from a cherub
Bank has an obligation to honor cherub when
the drawer has sufficient funds to cover it
Certified cheques insure that the instrument will
be honored by the bank
Treated like accepted bill of exchange
Copyright © 2004 McGraw-Hill Ryerson Limited
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CHEQUES
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Certification – undertaking by bank to pay
amount of check to holder when later
presented for payment
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By Drawer
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Bank certifies before delivery
Drawer entitled to return cherub for cancellation
Stop Payment (Countermanding) before delivery
terminates bank’s obligation to honor cherub
Not allowed once delivered to payee
Copyright © 2004 McGraw-Hill Ryerson Limited
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CHEQUES
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Certification by Holder
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Bank is liable for payment
Drawer becomes discharged from liability
Uncertified Cheque
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Similar to bill of exchange
Not legal tender
Conditional payment
Cheque dishonored
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Debt remains and action can be taken
Copyright © 2004 McGraw-Hill Ryerson Limited
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CHEQUES
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Postdated – date later than the time
delivered
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Post-dated cheques create a creditor/debtor
relationship
Stop Payment (Countermanded) – drawer
instructs bank not to pay check
Copyright © 2004 McGraw-Hill Ryerson Limited
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ENDORSEMENTS
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The process of signing a negotiable
instrument to enable negotiation
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By signing the back of a cherub or bill, an
endorser implicitly contracts that they will
compensate the holder or any subsequent
endorser if the cherub is dishonored
Types of Endorsements
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Endorsement in Blank - signing a cherub without
any special instructions
Restrictive Endorsement - signing a cherub for
deposit only to a particular bank account
Copyright © 2004 McGraw-Hill Ryerson Limited
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ENDORSEMENTS
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Types of Endorsements
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Special Endorsement - signing a cherub and
making it payable to a specific person
Conditional endorsement – condition on
endorsement
Qualified endorsement – denies liability “without
recourse”
Anomalous endorsement – added as a guarantee
Copyright © 2004 McGraw-Hill Ryerson Limited
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PROMISSORY NOTES
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Promises to pay the amount stated
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Used for granting credit
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May bear interest
May be paid by installment
Acceleration clause upon default
An IOU is not a negotiable instrument unless it is
designated payable on a certain date
Parties to a note
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Maker - person who makes note
Payee - person entitled to receive payment
Copyright © 2004 McGraw-Hill Ryerson Limited
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NEGOTIABILITY
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Negotiability – special quality possessed by
N.I. As a distinct class of assignable contract
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Transfer of instrument from one party to another
Transferred or assigned
Better rights - may give greater rights to the
bearer than the person from whom it was
received
Sue in own name
Copyright © 2004 McGraw-Hill Ryerson Limited
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NEGOTIABILITY
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Order Instrument
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By Endorsement and Delivery
Bearer Instrument
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By Delivery only
Copyright © 2004 McGraw-Hill Ryerson Limited
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THE LAW OF NEGOTIABLE INSTRUMENTS
ESSENTIALS OF NEGOTIABILITY
Copyright © 2004 by McGraw-Hill Ryerson Limited.
BILL OF EXCHANGE
Unconditional •
Order •
in Writing •
Signed by Drawer •
Addressed to Drawee •
Requiring the •
Drawee to Pay •
on Demand or •
at a Fixed or •
Determinable Future Time •
a Sum Certain in •
Money •
to the Order •
of a Specified •
Person or Bearer •
PROMISSORY NOTE
• Unconditional
• Promise
• in Writing
• Signed by Maker
• of the Note
• to Pay to, or
• to the Order of
• a Specific Person
• or Bearer
• on Demand, or
• at a Fixed or
• Determinable
• Future Time, a
• Sum Certain in
• Money.
Copyright © 2004 McGraw-Hill Ryerson Limited
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DEFENCES
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General rule – holder of an instrument entitled to
present the document for payment
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Each endorsement is deemed to have been made in the
order in which it appears on instrument
Prior endorsers must indemnify subsequent endorsers
Holder of an instrument, may obtain a better right than
an ordinary assignee under contract law
Exception: payment may be refused based on
various defenses
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Liability on instrument is subject to defenses
Copyright © 2004 McGraw-Hill Ryerson Limited
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DEFENCES
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Depends on relationship of parties
Depends on type of defense
Types of Parties
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Immediate party – people who deal directly with
each other
Holder – person in possession of instrument
Holder in due course – a person who acquires a
negotiable instrument before its due date that is
complete and regular on its face and who gave
value for the instrument, without any knowledge
of default or defect in the prior title holders
Copyright © 2004 McGraw-Hill Ryerson Limited
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DEFENCES
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Types of Defences
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Real Defences
Defect of Title Defences
Personal Defences
Each type of defense is good against a
particular party
Copyright © 2004 McGraw-Hill Ryerson Limited
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REAL DEFENCES
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Most effective defense
Effective against all types of parties
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Immediate party, holder, holder in due course
Defences that go to the root of the
instrument
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Instrument itself is defective
Copyright © 2004 McGraw-Hill Ryerson Limited
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REAL DEFENCES
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Forgery
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Signature of maker, drawer, or endorser is forged on
instrument
Incapacity of a Minor
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Minor cannot incur liability on an instrument
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Same defense may apply for an insane person
Lack of Delivery of an Incomplete Instrument
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Drawer or maker signs an incomplete instrument, but
does not deliver it
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Incomplete instrument – an instrument lacking some required
item
Date, amount, payee, etc
Need both incomplete instrument and lack of delivery
Copyright © 2004 McGraw-Hill Ryerson Limited
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REAL DEFENCES
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Material Alteration of the Instrument
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Material change to instrument
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Defense limited to changes made, does not affect the
enforcement of the instrument
Negligence on party drafting instrument may preclude
this defense
Fraud as the Nature of the Instrument
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Change in amount, payee etc.
Fraud as defense to payment
Limited to cases of non est factum
Cancellation of the Instrument
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If apparent on the face of the instrument
Copyright © 2004 McGraw-Hill Ryerson Limited
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DEFECT OF TITLE DEFENCES
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Instrument improperly obtained
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Not valid against holder in due course, only against
immediate parties and holders
Instrument has to be acquired in good faith without
notice of any problems associated with the original
transaction
Types of Defect of Title Defences
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Fraud
Duress
Undue influence
Illegal consideration
Failure of consideration
Breach of trust
Copyright © 2004 McGraw-Hill Ryerson Limited
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PERSONAL DEFENCES
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Defences affect the parties themselves, not
the instrument
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Only valid against immediate parties, not a
remote party
Types
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Set off – arising from a separate transaction
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Lack of consideration
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A defense of the indebtedness of the party claiming
payment
If holder and prior parties failed to give consideration
Release or payment before maturity
Copyright © 2004 McGraw-Hill Ryerson Limited
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DEFENCES
Holder
Holder in
Endorser
Due Course
Real
Defense
X
X
Defect of
Title
Defense
Personal
Defense
X
X
X
X (if
immediate
party)
Copyright © 2004 McGraw-Hill Ryerson Limited
X
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CONSUMER PROTECTION
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1970 Bills of Exchange Act amended to provide for
2 new types of instruments
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Consumer bills
Consumer notes
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Can be a check, a bill, or a note
Purpose: to protect consumers
Bills of exchange that arise out of a consumer
purchase
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Credit purchase
Purchased from a business who provides consumer
goods and services
Purchase for personal use
Copyright © 2004 McGraw-Hill Ryerson Limited
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CONSUMER PROTECTION
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Consumer instrument must be marked
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Marked “consumer purchase”
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Unmarked instruments are void
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Before or at time the bill or note is signed
Except in hands of holder in due course who had
notice it is a consumer instrument
Penalties for violation
Subject to any defenses consumer has
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Subject to the equities
All defenses available against all parties
Copyright © 2004 McGraw-Hill Ryerson Limited
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SUMMARY
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Governed by Bills of Exchange Act
Three types
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Negotiability
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Bill of Exchange
Cheque
Promissory Note
Transferability
Holder may obtain better rights
Defences
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Depends on type of party and type of defense
Copyright © 2004 McGraw-Hill Ryerson Limited
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