NEGOTIABLE INSTRUMENTS
Definition of Negotiable Instruments & Their Significance
Definition:
A negotiable instrument is a written document guaranteeing the payment
of a specific amount of money, either on demand or at a fixed future date, to
a specific person or to the bearer of the instrument. It can be freely
transferred from one person to another, giving the new holder the right to
collect the money.
Examples: cheques, bills of exchange, promissory notes.
Significance:
Transferability: Easy transfer of money without handling physical
cash.
Legal recognition: Governed by the Bills of Exchange Act (in
Kenya and similar laws elsewhere).
Credit facility: Encourages trade by allowing delayed payments.
Evidence of debt: Serves as written proof of an obligation to pay.
Security: Minimises risk of carrying large sums of cash.
Liquidity: Can be easily converted into cash.
2. Essential Characteristics of Negotiable Instruments
1. Freely transferable – Can be passed from one person to another by
delivery or endorsement and delivery.
2. Title of the transferee – The person who receives it in good faith and
for value gets a better title than the transferor.
3. Right to sue in own name – The holder can sue in their own name
without involving previous holders.
4. Unconditional promise/order – Must contain an unconditional
promise or order to pay.
5. Payment in money only – The amount must be payable in legal
tender, not goods/services.
6. Payable on demand or at a fixed/future date – Clear date or
condition for payment.
7. Certainty of amount – The amount payable must be clearly stated.
3. Main Types of Negotiable Instruments, Their Characteristics &
Discharge
A. Promissory Note
Definition: A written, unconditional promise by one party (maker) to
pay a specific sum of money to another party (payee) or order.
Characteristics:
o In writing and signed by maker
o Unconditional promise to pay
o Definite sum of money
o Payable on demand or at fixed date
Discharge:
o Payment in due course
o Cancellation
o Release by agreement
o Operation of law (e.g., bankruptcy)
B. Bill of Exchange
Definition: A written order by one person (drawer) directing another
(drawee) to pay a certain sum to a third person (payee) or order.
Characteristics:
o In writing and signed by drawer
o Unconditional order to pay
o Accepted by drawee
Discharge:
o Payment by acceptor
o Cancellation
o Agreement to discharge
o Lapse of time
C. Cheque
Definition: A bill of exchange drawn on a bank and payable on
demand.
Characteristics:
o Always drawn on a bank
o Payable on demand
o Must be signed by account holder
Discharge:
o Payment by bank
o Stop-payment order
o Expiry (usually 6 months)
o Destruction/cancellation
4. Parties to Each Type of Negotiable Instrument, Their Rights &
Duties
Promissory Note
Maker: Creates the note; duty to pay; right to be discharged after
payment.
Payee: Entitled to payment; duty to present note at maturity.
Bill of Exchange
Drawer: Orders payment; duty to compensate if bill dishonoured; right
to sue acceptor.
Drawee/Acceptor: Agrees to pay; duty to honour bill; right to
reimbursement from drawer.
Payee: Receives payment; duty to present on maturity.
Cheque
Drawer (account holder): Orders bank to pay; duty to maintain
funds; right to countermand payment.
Drawee (bank): Pays the cheque; duty to honour if funds available;
right to charge drawer’s account.
Payee: Receives payment; duty to present cheque promptly.
5. Endorsement of a Bill of Exchange
Definition: Signing the back (or face) of a bill of exchange by the holder to
transfer it to another person.
Types of Endorsement:
Blank endorsement: Only signature; instrument becomes payable to
bearer.
Special endorsement: Specifies the person to whom payment should
be made.
Restrictive endorsement: Limits further transfer (e.g., “Pay X only”).
Conditional endorsement: Payment subject to a condition.
Significance:
Transfers ownership
Establishes legal right to collect payment
Provides chain of title
6. Crossing of a Cheque – Kinds & Significance
Definition: Drawing two parallel lines across a cheque with or without
additional words to restrict its payment.
Kinds of Crossing:
General Crossing: Two parallel lines; payment only through a bank.
Special Crossing: Lines plus name of a specific bank; payment only
through that bank.
Restrictive Crossing: Additional instructions like “A/C Payee Only”;
ensures payment only to account holder.
Significance:
Increases security by preventing encashment by unauthorized persons.
Ensures payment through bank account, leaving a record.
Reduces fraud risks.