What is Negotiable Instruments?

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Negotiable instruments, unlike non-negotiable instruments, are transferable. Hence, they can move from one person or party to another until it reaches the final holder, who holds the complete right to use them. The one who issues them is a payer, whereas the one it is issued for is the payee.  

Negotiable Instruments Explained

Negotiable instruments assure payment/repayment to an entity or individual. These legal documents are so prepared that the time of payment and the recipient’s name are mentioned. Such instruments are written promises signed by payers and made to payees, per which the former guarantees to make the payment on the mentioned date or on-demand. 

Key Takeaways

  • Negotiable instruments are written and signed legal documents that ensure a party pays or repays another party within a set period or on-demand.These are the safest modes of payment as they contain the name of the issuer and the name of the recipient on them.Such financial products are easily transferable, and individuals are free to either encash them or transfer them to consecutive payees.Some such instruments include – promissory notes, checks, Certificates of Deposit (CD), money orders, bearers bonds, etc.

These are nothing but evidence of indebtedness, as the instrument holder has an unconditional right to recover the amount of money stated in the instrument from its maker. These instruments are used as a substitute for cash to safely transfer the payments between the merchants and have a risk-free business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company’s financial statements.read more.

These legal notes make individuals and entities trust each other with payments and repayments. They are negotiable as these notes or drafts involve two parties that agree to take forward a transaction. Though unconditional, these documents must have the assignee’s name mentioned on them. Hence, the payment is made to the mentioned payee only.

Features

These documents exhibit a wide range of characteristic traits. For example, some of the negotiable instruments features include:

  • It is a written document signed by the issuer.It is like a valid contract easily transferable from one party to another. The holder can transfer the document to another individual or entity without hassle. It is this feature that makes such instruments negotiable.As named on the instrument, the payee enjoys complete ownership of the legal document. This means the title gets transferred when the note is handed over to the consecutive parties.A negotiable instrument always mentions the payee’s name, which signifies making the payment to a specific person or firm.In addition to the payee, the time is also predetermined and is certain. A payee can present the document to encash it or receive the payment as promised within the specified date or on-demand.There is flexibility as the payee can receive the funds in cash or transfer the document to another party for consecutive usage.

Types of Negotiable Instruments

These legal drafts and notes are available in wide varieties. Some of the widely found negotiable instruments types are as follows:

Checks

A check is a note containing the amount paid by one party to another party. It includes the bearer’s name and account number from which the money would be debited. In addition, it also mentions the name of the payee. As a result, even if the check goes missing, no third party can misuse it. In short, checks are the safest mode of making payments or transferring funds from one party to another.

Though debiting the amount from one account and crediting the same in the other takes a bit more time, people still consider issuing a check for safety reasons. People and firms use various checks, like traveler’s checks, personal checks, certified checksCertified ChecksA certified cheque is where the issuer bank guarantees on behalf of the account holder that they have an adequate amount of cash in the account to honour the recipient cheque. In addition, it verifies the authenticity of the account holder’s signature on the cheque.read more, cashier’s checks, etc. 

Promissory Notes

A promissory notePromissory NoteA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date.read more means one party promises to pay a sum of rupees to another party whose name is mentioned on the note along with a fixed future date. Generally, it is used as short-term trade creditTrade CreditThe term “trade credit” refers to credit provided by a supplier to a buyer of goods or services. This makes it is possible to buy goods or services from a supplier on credit rather than paying cash up front.read more, , and the maker pays the due amount on or before the note’s expiry. As a safe mode of transferring money, business people frequently use it to have smooth business transactions. 

Individuals or firms can claim the outstanding funds after the expiry of the term in the event of non-payment of the promised money. It is also issued as a debt instrumentDebt InstrumentDebt instruments provide finance for the company’s growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more, which corporations use to finance their short-term projects.

Certificates of Deposit (CD)

Banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more offer Certificate of DepositCertificate Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period.read more as a financial product. In the process, the customers deposit a certain amount and keep it safe for a fixed tenure while receiving a high-interest rate on the amount in return. The interest rate tends to increase constantly with the increasing deposit span. The individuals can withdraw the amount plus interest once the CD matures. However, in case of early withdrawal, one would need to pay the penalty.

Bills of Exchange

Bills of ExchangeBills Of ExchangeBills of exchange are negotiable instruments that contain an order to pay a certain amount to a particular person within a stipulated period of time. The bill of exchange is issued by the creditor to the debtor when the debtor owes money for goods or services.read more are similar to promissory notes and can be used for national and international tradeInternational TradeInternational Trade refers to the trading or exchange of goods and or services across international borders. read more. Using this instrument, one party promises to pay the sum of money to another party or any other person on a fixed future date. The person it is endorsed for is the drawee, who has a valid claim on the bill writer or the drawer for the amount mentioned on the bill.

Money Orders

It is a substitute for the check for making payments on-demand. In a money order, the amount is specified. To process the money order, the payer has to pay the amount to a financial institution beforehand and a small processing fee. In return, the financial institution issues the money order. It has long been the traditional way of transferring money from one party to another with utmost security guaranteed. These are the best mode of money transfer for those who do not possess a bank account.

Bearer Bonds

These are the unregistered bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more issued by the Government or Corporate, and as the name suggests, the bondholder is entitled to get a coupon and principal paymentPrincipal PaymentThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan’s original amount is directly reduced.read more thereon. The issuer doesn’t keep the record of the original bond owner. Whoever has physical possession of the bearer bondsBearer BondsBearer Bond, also known as a Coupon Bond, is a debt security issued by a company, corporation, or Government & it has no registered owner as whoever is holding it becomes the owner. read more will be treated as the legal owner. Therefore, there is a huge risk of loss, theft, or otherwise the destruction of these bonds.

Examples

Let us consider the following negotiable instruments examples to understand the concept better:

Example 1

Anne applied for a loanLoanA loan is a vehicle for credit in which a lender will give a sum of money to a borrower or borrowing entity in exchange for future repayment.read more of $100,000 from a banking institution. The bank checks her credit scores and verifies her income and other proof to ensure she can repay the amount. However, in receiving repayment assurance, the bank asks Anne to sign a promissory note to ensure repayment in time.

In the event of default, despite all verifications, the promissory note will give the bank the right to legally claim the amount or take the borrower to the court of law to settle things further.

Example 2

Multiple nations have introduced certain laws to ensure the ethical usage of these instruments and also the security of the payee’s rights. For example, India enforced the Negotiable Instruments Act, 1881, to govern the practices of using the above instruments effectively, including the rights, duties, and obligations of parties involved in the transactions. 

However, recently, India introduced The Negotiable Instruments (Amendment) Bill, 2017, to safeguard the rights of the payeesPayeesA payee refers to a person, business, government, or any other entity that receives payment for providing goods or services.read more in case of dishonor of checks.

Negotiable Instruments – Current Trends

While most of the negotiable instruments have already witnessed a downtrend and have become less preferred among individuals and entities, there are a few of them, the use of which is still trending. 

Today, the virtual mode of transactions has become way more popular. Therefore, individuals and businesses tend to use online banking channels to ensure transactions do not take much time and occur instantly. Nowadays, people are more comfortable doing transactions through NEFT, RTGS, debit & credit cards, etc.

Though the time taken for transactions is less in the case of modern financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more, the security concerns are major. As a result, when the sum or amount to be transferred is huge, people still prefer using traditional money transfers, like issuing checks, money orders, etc.

This is a guide to Negotiable Instruments, their meaning, features, and types. Here we discuss what is its usage with the help of some practical examples. You may also take a look at the following articles to learn more –

A negotiable instrument is a legal document written and signed by one party to ensure it will pay or repay the required amount within a specific time range or on-demand. It is transferable, and an individual or entity has the liberty to decide whether they want to encash it or transfer it to consecutive payees. Some of such instruments include checks, promissory notes, Certificates of Deposit, Bills of Exchange, money orders, etc.

A banknote, promissory note, checks, draft, and money order are the most widely used negotiable instruments in banking.

Yes, bonds issued by the government and corporates are negotiable forms of instruments. The ones possessing ownership currently are only considered as the complete owner. The issuer has nothing to do with the original bond owner.

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