What is negotiability and why is it important?

Negotiation is the transfer of negotiable paper from one holder to another. To be a substitute for money, commercial paper must be freely transferable in the marketplace. That is, the paper must be negotiable. Negotiability concerns the rights of the holder of commercial paper. Paper that is not negotiable may still be transferred; however, it is far less valuable than negotiable paper. This is because the holder has fewer rights in enforcing payment of the non-negotiable, commercial paper. 

What are the Characteristics of Commercial Paper?

The rights of a holder of each type of paper is as follows:

What is Non-negotiable Commercial Paper? 

An individual in possession of a non-negotiable instrument stands in the shoes of the original issuee. That is, she has the exact same rights in the instrument as the original issuee held. This means that, if the original party loses his right to be paid (think of defenses to payment of a contract), so does the transferee of the commercial paper. As such, the value of non-negotiable instrument is far less valuable to a subsequent transferee who cannot be certain that she will receive payment without being subject to a payor defense.

Example: Sarah enters into a contract to sell equipment to Robert. Robert gives Sarah a non-negotiable promissory note to pay for the goods. So, Sarah is the holder of a promissory note that is non-negotiable. She transfers the note to Tim, who is now the holder. If Robert has a defense against his obligation to pay Sarah for the equipment (e.g., the equipment is faulty), he could assert that defense against his obligation to pay Tim if he presents the promissory note for payment. This possibility makes the note far less valuable to Tim.

What is Negotiable Commercial Paper?

The holder of negotiable paper may have greater rights than the original issuee. That is, when paper is negotiable and validly negotiated to a subsequent holder who qualifies as a holder in due course, the holder may acquire greater rights to enforce the instrument against the payor or maker. The holder in due course will have a greater right to payment because the maker or payor cannot assert certain defenses (personal defenses) to payment against the holder in due course.

Example: In the above scenario, suppose Robert provides Sarah with a negotiable promissory note. This means that it is transferable without conditions. If Tim later presents the note for payment, Roberts defense against paying Sarah on the underlying contract does not apply to the promissory note. Robert will be liable if he fails to pay it. Robert may still sue Sarah, but this right is completely separate from his obligation on the promissory note.

Related Topics

• Commercial Paper (Intro)
• What is Commercial Paper?
• Negotiable Instrument
• What are the common types of commercial paper?
• Promissory Note
• Cashier's Check
• Convenience Check
• Certified Check
• Substitute Check
• Bill of Exchange
• Bank Draft Definition
• Sight Draft Definition
• Bankers Acceptance 
• Who is a Holder of a negotiable instrument?
• Commercial Paper Funding Program
• What is Negotiability and why is it important?
• What is required for commercial paper to be negotiable?
• Sum Certain (Contracts)
• Inflation Adjustment Clause
• When does commercial paper contain an Unconditional promise to pay?
• Backup Line of Credit
• What is Payable on Demand or Payable on Time?
• What is Order Paper and Bearer Paper?
• Bearer Form
• How is a payee identified on the negotiable instrument?
• What rules does the court apply in determining negotiability?
• How is commercial paper negotiated to a holder?
• What is Transfer of a negotiable instrument?
• What is Indorsement of a negotiable instrument?
• What are the various types of indorsement?
• Bank Endorsement
• Blank Endorsement
• Accommodation Endorsement
• How does a holder receive payment on a negotiable instrument?
• Who is potentially liable on (or obligated to pay) a negotiable instrument?
• When is an individual liable for a representative signing a negotiable instrument?
• What rules apply if a holder loses a negotiable instrument?
• When is payment of a negotiable instrument overdue?
• What effect does a negotiable instrument have on the underlying obligation?
• What is a holder in due course?
• What are the requirements for a holder to become a holder in due course?
• Receive an instrument for value?
• Receive an instrument in good faith?
• Receive an instrument without notice of a valid defense?
• How does discharge of the Underlying Obligation affect a holder in due course?
• What is the Shelter Rule?
• Can you limit a transferee from becoming a holder in due course?
• Personal Defenses?
• Real Defenses?
• What is a Claim in Recoupment?
• What are the rights of a holder in due course if the instrument involves a consumer transaction?
• What happens if a negotiable instrument is Forged?
• What happens if a negotiable instrument is Stolen?
• Guaranty or Guarantee
• Letter of Guarantee
• Personal Guarantee
• What is the role of a Guarantor or Surety of a negotiable instrument?
  
• Surety 
  
• Cosign
• Accommodation Paper Definition
• Secondary Liability
• Avalize Definition
• What is an Accord & Satisfaction?
• What is primary and secondary liability on an instrument?
• What is Drawer or Maker Liability for a negotiable instrument?
• What is Transferor Warranty of a negotiable instrument?
• What is Indorser Warranty of a negotiable instrument?
• What is Presentment Warranty of a negotiable instrument?
• What is a warrantors liability for a dishonored note or draft?
• What is the time limitation for warranty of a negotiable instrument?
• When are the warranties of a negotiable instrument discharged?