CHAPTER 10
THE LAW OF NEGOTIABLE INSTRUMENTS
LEARNING GOALS
- To examine the law relating to cheques, bills
of exchange and promissory notes.
- To describe the various kinds of negotiable
instruments and their role in business transactions.
- To consider their enforceability and defences to payment.
- To examine how consumer protection legislation applies
to negotiable instruments.
CHAPTER COMMENTARY
The law of negotiable instruments has a long and interesting history, which explains in part many of the special features that attach to certain kinds of notes, and the reasons why special rights are sometimes vested in the holder. For this reason, as a part of the review of this material, the various instruments might be discussed in terms of their original purpose and present day use. For example, the cheque, which is a bill of exchange, is now widely used as a result of the growth of the banking system and commerce in general. While virtually everyone today is familiar with this type of negotiable instrument, prior to the middle of the 19th Century, only business persons used them regularly.
Because the law relating to negotiable instruments has its roots in the Law Merchant, it has associated with it a legal vocabulary of its own. Such terms as drawer, drawee, endorser, holder in due course, sight drafts, restrictive endorsements, bearer, and 'without recourse' have special meanings in connection with bills of exchange, and their significance should be committed to memory.
A systematic approach to the topic might be to suggest that the students read the chapter, then prepare a list of definitions of the new terms. The text material may then be read again, using the list of definitions where necessary, as each of the different negotiable instruments are discussed.
Most students are familiar with the cheque, which is a type of bill of exchange. It differs from the ordinary bill of exchange in that it is always drawn on a bank, and is payable on demand (except, of course, where the cheque is postdated). The bank upon which the cheque is drawn is a special type of drawee, however, and need only make payment when it has sufficient funds on hand in the drawer's account to pay the face amount of the cheque. The significance of a certified cheque is discussed on pages 274-275.
The general layout of a cheque is as follows:
July 4, 20--
Pay to the
Order of------ABC Store Ltd.------$100.50
------One Hundred------50/100 Dollars
The Friendly Bank
1 Any Street A. Doe Any Place, Canada
The bill of exchange resembles the cheque in many respects, as a comparison of the above layout with the illustration of a bill of exchange on p. 272 of the text will attest. Comparing the two illustrations, the similarities should become apparent. For example, the drawee in the bill of exchange is "B.C. Sales Inc. instead of the bank above, and the order of payment is to Smith Wholesale Co. In the text illustration, the bill has provision for acceptance in the upper left hand corner, but this would not be necessary with a demand bill (such as a cheque), since payment would be expected on presentation.
The promissory note is also covered by the Bills of Exchange Act, and differs from the bill of exchange in that it is a promise to pay, and it does not require acceptance, since the maker is the party who prepares and signs the promise. As the text indicates, it must meet the essentials of negotiability if it is to be treated as a negotiable instrument. These essentials are set out on the chart that accompanies this chapter. A promissory note, however, must be delivered before the maker becomes liable on it.
The defences to the payment of a bill of exchange should be noted, because there are many reasons why a bill may not be legally enforceable against a party. These defences may be divided into the three categories set out in the text:
(1)real defences.
(2)defect of title defences.
(3)mere personal defences.
Consumer protection legislation, and its effect on transactions that involve negotiable instruments should also be discussed, to illustrate the general trend of the law toward the restriction of the special rights of holders in due course to nonconsumer situations.
REVIEW QUESTIONS
1. Define a bill of exchange. Indicate how it is determined to be "negotiable."
Answer:
A bill of exchange is an unconditional order in writing, addressed by one person to another, signed by the person giving it, and requiring the person to whom it is addressed to pay either on demand or at a fixed or determinable future time, a sum certain in money to, or to the order of, a specified person or bearer. The bill must meet these requirements to be negotiable.
2. How does a cheque differ from the usual type of bill of exchange?
Answer:
A cheque is a bill of exchange that is always drawn on a bank and is payable on demand as a demand bill.
3. Why is acceptance of a bill of exchange important?
Answer:
Acceptance is important because it is the "signing" of the bill by the drawee that renders the drawee liable on it.
4. What is the purpose of a bill of exchange in a modern commercial transaction?
Answer:
A bill of exchange in a modern commercial transaction is used to ensure payment by the buyer of goods, and to enable the seller to use the promise of payment (the bill of exchange) as a means of financing its own business by way of endorsement to others. It also reduces risk by replacing the need to exchange money.
5. Distinguish a sight bill from a demand bill.
Answer:
A sight bill has 3 days grace added for payment. A demand bill is payable on presentation.
6. Define a holder in due course. Explain how a holder in due course differs from an ordinary holder of a bill of exchange.
Answer:
A holder in due course is a person who in good faith, takes a bill of exchange complete and regular on its face, for value, before maturity, and without notice of any defect or prior dishonour. A holder in due course of a bill of exchange is subject only to real defences in any claim for payment.
7. Outline the procedure to be followed when a bill of exchange is dishonoured by non- payment.
Answer:
When a bill of exchange is dishonoured, the holder must give notice to the drawer, payee and any other prior endorser not later than the business day next after the dishonour occurs.
8. How does a certified cheque differ from an ordinary cheque?
Answer:
A certified cheque differs from an ordinary cheque in that certification renders the bank that certified the cheque is liable when the cheque is later presented for payment.
9. Define a promissory note. Distinguish it from a bill of exchange.
Answer:
A promissory note is an unconditional promise in writing, signed by the 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. It differs from a bill of exchange in that it is a promise rather than an order to pay.
10. Explain how an endorsement in blank differs from a restrictive endorsement. Explain the circumstances under which each might be used.
Answer:
An endorsement in blank turns the instrument into a bearer document. A restrictive endorsement restricts the negotiation to the person named in the endorsement. The former permits anyone in lawful possession of the instrument to negotiate it, the latter may be used to restrict negotiation to one person, or to prevent negotiation to anyone if the endorsement is restricted to read "for deposit only to the credit of ______."
11. Promissory notes that call for installment payments often contain acceleration clauses. Why is this so, and what is the purpose of such a clause?
Answer:
If a promissory note calls for installment payments, default on one payment would only entitle the holder to take action to recover the single payment. An acceleration clause causes the balance of the debt to become due and payable immediately on the default of a single payment.
12. When a holder in due course of a promissory note attempts to enforce payment, what types of defences might be raised by the maker named in the note?
Answer:
Only a real defence (forgery, minority of maker, etc.) may be raised against a holder in due course.
13. What is a "defect of title" defence? What type of holder of a promissory note or bill of exchange would this type of defence be effective against? "
Answer:
A defect of title defence may be raised against a holder (but not a holder in due course). Defect of title defences include fraud, duress, undue influence, illegal consideration, total failure of consideration, etc.
14. Outline the various personal defences available. Indicate the type of holder that they might be raised against.
Answer:
A mere personal defence is a defence that may be raised against an immediate party. These include: setoff, absence of consideration, release, or payment before maturity.
DISCUSSION QUESTIONS
1. In Ask A Lawyer, the small business owners have their first encounter with a bill of exchange. Explain this document and how it will be processed to cover the payment for the goods received.
Comment:
The advice of the lawyer in this case would probably be the information set out in Figure 10-1 on p. 272 of the text, as well as the definition and discussion of the bill of exchange on the preceding page. The lawyer would also note that a cheque is a special type of bill of exchange, and explain that the bill of exchange is a useful instrument to facilitate the sale of goods, as once accepted it may be negotiated by the drawer for the financing of the drawer’s business. Because most bills of exchange are time bills, they also give the drawee time to sell some of the goods before payment is due, thereby reducing the financing costs of the purchase of the goods.
2. Explain how the changes in the law concerning consumer purchases affects the parties to a transaction where a vehicle is purchased on credit using an installment note that is then sold to a finance company by the seller of the vehicle.
Comment:
The purchase of a vehicle is often for a significant amount of money. The installment note permits the purchaser to pay for the vehicle over a period of time. The seller of the vehicle will often sell the note to a finance company, who, as assignee, will collect the payments as they fall due.
If the purchaser is a consumer, the note must be marked “consumer note” as required by the legislation. This allows the consumer/purchaser to raise any defence to payment against the finance company that the consumer would be entitled to raise against the seller, if the seller should be in breach of the contract of sale. This protects the consumer, as the finance company would otherwise be able to claim payment as a holder in due course, leaving the consumer only with recourse against the seller if breach occurs in the contract of sale.
COMMENTS RE: DISCUSSION CASES
CASE 1
Henri was in the process of negotiating the purchase of a high-end laptop computer from The Computer Supply Co. As a result of a number of telephone calls to the Computer Supply Co., Henri eventually negotiated a price of $3,200 for the computer. He prepared a cheque in the amount of the purchase price and signed it. However, because he was uncertain as to the exact spelling of the company name, he left that part of the cheque blank. He placed the signed cheque in his office desk drawer with the intention of making a telephone call to the company later in the day for the information necessary to complete the cheque.
Henri determined the company's correct name while at lunch, but when he returned to the office, he discovered that the cheque had been stolen.
Shar, a fellow employee of Henri’s, had taken the cheque, filled in the cheque payable "to bearer," and used it to purchase items at a store where Henri frequently shopped. The store owner accepted Henri’s cheque without question, as he was familiar with his signature, and later presented it to Henri’s bank for payment.
Within minutes after the bank had paid the cheque, Henri telephoned to have the bank stop payment.
Advise the parties of their respective rights (if any) and liability (if any).
Comment:
The cheque in this case was incomplete, but signed by Henri before it was stolen. The cheque appeared to be complete and regular on its face when presented for payment. Both the shop owner and the bank recognized the signature as genuine. Henri did not notice the cheque missing until after the bank had made payment. The question is: what should be done? The bank paid the cheque as a genuine instrument. Should it suffer the loss? Should the shopkeeper? Shar was the culprit in the case should he not be liable?
Absence of delivery of an incomplete instrument is a real defence, good against all holders (see text p. 281) but was Henri negligent in leaving the cheque in his desk? Probably not. Does it make any difference that payment had been made? Henri would be entitled to recover the amount from the shopkeeper, who in turn, could look to Shar for payment. For a example of a case where a bill was stolen and negotiated, see: Baxendale v. Bennett (1878), 3 Q.B.D. 525.
CASE 2
Food wholesale Co. sold the Happy Restaurant Ltd. a large order of goods for $3,000 on 30 days credit. As agreed by the parties, Food Wholesale Co. drew a bill of exchange on the Happy Restaurant Ltd. naming itself as payee. The bill was payable in 30 days time. The Happy Restaurant Ltd. accepted the bill and returned it to Food Wholesale Co. Food Wholesale Co. then endorsed the bill to Speedy Transport Ltd. to cover its indebtedness for transportation services provided by the company. Speedy Transport Ltd., a small firm, endorsed the bill in blank to Hendriks, the company's office manager as a retirement gift, rather than wait until the bill became due to obtain the funds. Hendriks, on receipt of the bill, delivered it without endorsing it to his friend, Basil, whom he owed a sum of money. Basil, in turn, endorsed the bill and sold it to Black for $2,800. On the due date, Black presented the bill for payment, and it was dishonoured.
Advise Black of his rights. Explain the liability(if any) of each of the parties.
Comment:
The acceptance of the bill of exchange by Happy Restaurant Ltd. rendered it liable for payment to the holder. When the bill was presented for payment by Black, who was a holder in due course, and dishonoured by Happy Restaurant Ltd., Black must give notice of dishonour to all other endorsers by the business day next after the dishonour. See: Bills of Exchange Act, s. 97). Prior endorsers must follow the same procedure. Note, however, that Hendriks is not an endorser as he received the bill endorsed in blank and delivered it to Basil without endorsing it.
Since all prior endorsers, the drawer, and the drawee are liable on the bill, Black may look to them for payment. All of the parties (except Hendriks, who was not an endorser) gave value for the bill, and each may hold the prior endorser liable if they should be obliged to pay. In the end, if this process is followed, Food Wholesale Co. will be obliged to pay, and must look to Happy Restaurant Ltd. for payment. (See: Bill of Exchange Act s. 95101).
CASE 3
Able bought a number of books from The Book Box Store Limited in a single mail order, and enclosed a cheque for $240 with the order, drawn on the Big City Bank. In the interval between mailing the order and the arrival of the products, Able noticed a number of the books (totaling $120) were available at a lower price at a local book store.
On the day the books arrived, he visited the bank and was pleased to see that his cheque had not yet been cashed. He placed a stop payment order on the cheque, and in filling out the request slip, placed the words "goods unsatisfactory" in the box allotted for the reason for the request. Able sent back the part of the order that he had now bought more cheaply elsewhere, and assumed that The Book Box Store Limited. would send him a new invoice for $120.
The Big City Bank failed to immediately enter the request into its computer system, and as a result, on the arrival of the cheque a day later, it paid Able's cheque out of his account in the normal manner. Able discovered this error in the course of using an automated cash machine a few days later, and asked the bank to correct the error. The bank put $240 back into Able’s account and told him that they would collect back the $240 that they had paid The Book Box Store Limited 's bank, The Business Bank. The Big City Bank returned the cheque in the clearing system, now marked "Payment Stopped," and demanded $240 from The Business Bank.
The Business Bank refused the stopped cheque and would not make payment back, stating that by accepted banking convention, too much time had elapsed between acceptance by the Big City Bank and the return of the item. While this had been going on, The Book Box Store Limited had received the goods returned by Able and had mailed him a refund cheque for $120, for as far as they knew, they had been paid in full.