Volume 42 | Number 3 Summer 2007
Page 2 of 6
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I. Survey of Negotiation of Drafts in the Law of Negotiable Instruments1
Negotiation in the law of negotiable instruments is a special transfer of intangible rights in a negotiable instrument, which entitles the transferee to claim under the instrument as if it were payable directly to it, transfer it in a similar manner to others, and claim under appropriate circumstances that it takes free of certain defenses that could have been raised against the drawer or prior transferees.2
While there are differences as to how one becomes entitled to exercise these rights, these differences have little practical significance in discussing negotiability in connection with letters of credit, and the common law and civil law identify this person as a “holder.”3
Negotiation in the law of negotiable instruments has certain formal prerequisites. Not just any promise or order to pay can be negotiated. To be negotiated, it must be in the form of a negotiable instrument—it must meet certain formal requirements, which include being unconditional.4
Because the concept of negotiation necessarily involves the use of abstract terminology drawn from the major legal regimes, it is easier to explain how negotiation occurs than what it is. Negotiation of a negotiable instrument always entails the delivery of the instrument to an entity who becomes a holder. Where the instrument is issued in bearer form or indorsed in blank or to bearer, only delivery is required to effect a negotiation. Where the instrument is issued to the order of a named entity or entities or issued in bearer form and indorsed to a named entity or its order, the delivery must be accompanied by the indorsement of that entity.5
By issuing a negotiable instrument as a drawer or by indorsing it, an entity makes certain promises to subsequent holders to whom the instrument is negotiated or who can claim as a transferee of such a person, namely that it will honor the instrument if it is dishonored on maturity by the drawee or a subsequent indorser provided that any necessary notice is given.6 To disclaim this obligation on the instrument, it is necessary to indicate that the indorsement (or issuance) is “without recourse.” An indorsement or issuance without recourse signifies that in the event of its dishonor by the drawee, there is no recourse available on the instrument against the indorser or issuer. Absent such a disclaimer, it is assumed that any person signing an instrument as drawer or indorser makes such an undertaking.
In the case of a negotiable instrument, negotiation is undertaken by the entity that is in possession of the instrument to whom it runs (holder) and is transferring (negotiating) it. One would typically speak of negotiation by the transferor and not by the transferee. It is the transferee to whom the negotiable instrument is negotiated.