Copyright © 2004 McGraw-Hill Ryerson Limited 1 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 2 THE LAW OF NEGOTIABLE INSTRUMENTS 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 3 INTRODUCTION 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 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 4 ESSENTIAL CHARACTERISTICS OF A NEGOTIABLE INSTRUMENT 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 5 ESSENTIAL CHARACTERISTICS OF A NEGOTIABLE INSTRUMENT Consideration – instruments has own consideration Two contracts – promise supports 2 different contracts Sale Instrument Privity of contract Instruments are an exception to the rule Anyone with instrument can sue or be sued regardless of privity Assignment of contract: subject to the equities

Copyright © 2004 McGraw-Hill Ryerson Limited 6 HISTORICAL DEVELOPMENT Allowed for trade between merchants in different places 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 Adopted in Canada Applies to all types of negotiable instruments Applies federally

Copyright © 2004 McGraw-Hill Ryerson Limited 7 THE BILLS OF EXCHANGE ACT Applies to bills of exchange, cheques, and promissory notes Mandatory rules, parties cannot agree otherwise Advantages: Convenience – suitable substitute for money Credit – can be used to create credit Negotiability – ability to be readily transferred to another party 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 8 BILLS OF EXCHANGE ACT 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 9 BILLS OF EXCHANGE ACT 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 10 BILLS OF EXCHANGE Bill of Exchange (B.O.E.) 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 11 BILLS OF EXCHANGE 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 12 BILLS OF EXCHANGE 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 13 LIABILITY OF PARTIES (BILL OF EXCHANGE) Acceptance of a bill – renders the drawee liable to pay the bill according to the bill Must be presented by holder at place specified If payment refused holder must act quickly Bill dishonored Holder can sue drawer, acceptor and endorsers Must give notice of dishonor

Copyright © 2004 McGraw-Hill Ryerson Limited 14 CHEQUES A bill of exchange drawn on a bank and payable on demand Primary purpose the exchange of funds Issuing a Cheque 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 15 CHEQUES Delay 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 16 CHEQUES Certification – undertaking by bank to pay amount of check to holder when later presented for payment By Drawer 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 17 CHEQUES Certification by Holder Bank is liable for payment Drawer becomes discharged from liability Uncertified Cheque Similar to bill of exchange Not legal tender Conditional payment Cheque dishonored Debt remains and action can be taken

Copyright © 2004 McGraw-Hill Ryerson Limited 18 CHEQUES Postdated – date later than the time delivered Post-dated cheques create a creditor/debtor relationship Stop Payment (Countermanded) – drawer instructs bank not to pay check

Copyright © 2004 McGraw-Hill Ryerson Limited 19 ENDORSEMENTS The process of signing a negotiable instrument to enable negotiation 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 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 20 ENDORSEMENTS Types of Endorsements 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 21 PROMISSORY NOTES Promises to pay the amount stated Used for granting credit 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 Maker - person who makes note Payee - person entitled to receive payment

Copyright © 2004 McGraw-Hill Ryerson Limited 22 NEGOTIABILITY Negotiability – special quality possessed by N.I. As a distinct class of assignable contract 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 23 NEGOTIABILITY Order Instrument By Endorsement and Delivery Bearer Instrument By Delivery only

Copyright © 2004 McGraw-Hill Ryerson Limited 24 THE LAW OF NEGOTIABLE INSTRUMENTS ESSENTIALS OF NEGOTIABILITY Copyright © 2004 by McGraw-Hill Ryerson Limited. BILL OF EXCHANGEPROMISSORY NOTE 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 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 25 DEFENCES General rule – holder of an instrument entitled to present the document for payment 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 Liability on instrument is subject to defenses

Copyright © 2004 McGraw-Hill Ryerson Limited 26 DEFENCES Depends on relationship of parties Depends on type of defense Types of Parties 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 27 DEFENCES Types of Defences Real Defences Defect of Title Defences Personal Defences Each type of defense is good against a particular party

Copyright © 2004 McGraw-Hill Ryerson Limited 28 REAL DEFENCES Most effective defense Effective against all types of parties Immediate party, holder, holder in due course Defences that go to the root of the instrument Instrument itself is defective

Copyright © 2004 McGraw-Hill Ryerson Limited 29 REAL DEFENCES Forgery Signature of maker, drawer, or endorser is forged on instrument Incapacity of a Minor Minor cannot incur liability on an instrument Same defense may apply for an insane person Lack of Delivery of an Incomplete Instrument Drawer or maker signs an incomplete instrument, but does not deliver it 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 30 REAL DEFENCES Material Alteration of the Instrument Material change to instrument Change in amount, payee etc. 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 Fraud as defense to payment Limited to cases of non est factum Cancellation of the Instrument If apparent on the face of the instrument

Copyright © 2004 McGraw-Hill Ryerson Limited 31 DEFECT OF TITLE DEFENCES Instrument improperly obtained 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 Fraud Duress Undue influence Illegal consideration Failure of consideration Breach of trust

Copyright © 2004 McGraw-Hill Ryerson Limited 32 PERSONAL DEFENCES Defences affect the parties themselves, not the instrument Only valid against immediate parties, not a remote party Types Set off – arising from a separate transaction A defense of the indebtedness of the party claiming payment Lack of consideration If holder and prior parties failed to give consideration Release or payment before maturity

Copyright © 2004 McGraw-Hill Ryerson Limited 33 DEFENCES HolderHolder in Due Course Endorser Real Defense XXX Defect of Title Defense XX Personal Defense XX (if immediate party)

Copyright © 2004 McGraw-Hill Ryerson Limited 34 CONSUMER PROTECTION 1970 Bills of Exchange Act amended to provide for 2 new types of instruments Consumer bills Consumer notes Can be a check, a bill, or a note Purpose: to protect consumers Bills of exchange that arise out of a consumer purchase Credit purchase Purchased from a business who provides consumer goods and services Purchase for personal use

Copyright © 2004 McGraw-Hill Ryerson Limited 35 CONSUMER PROTECTION Consumer instrument must be marked Marked “consumer purchase” Before or at time the bill or note is signed Unmarked instruments are void 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 Subject to the equities All defenses available against all parties

Copyright © 2004 McGraw-Hill Ryerson Limited 36 SUMMARY Governed by Bills of Exchange Act Three types Bill of Exchange Cheque Promissory Note Negotiability Transferability Holder may obtain better rights Defences Depends on type of party and type of defense