13. What is “indorsement” of a negotiable instrument?
Indorsement of an instrument means signing it. The indorsement signifies that the individual signing the instrument certifies certain things about it to the primary parties liable on the instrument (maker or drawer) and to any subsequent holder of the document.
• Note: Indorsement indicates that the instrument is payable in accordance with its terms. If the instrument proves not to be payable in accordance with its terms, this can lead to liability for the indorser.
If paper being negotiated is order paper (as apposed to bearer paper), the paper must be indorsed by the person to whom the paper is payable prior to transfer to another holder. Indorsement by the payee may change the paper from order to bearer paper (and vice versa), as well as put other limiting characteristics on the instrument. A payee may indorse the instrument to make it bearer paper or have a special/restrictive/qualified/anonymous indorsements to limit the rights of the future holder of the paper.
• Note: Indorsement of an instrument by an imposters and fictitious payee does not destroy a negotiation.
Indorsement is not always required for negotiation of the instrument. No indorsement is required to negotiate commercial paper if the paper in possession of the transferor is bearer paper. As such, the mere transfer of possession is a negotiation. In this case, even involuntary transfer (such as when the paper is lost or stolen) or voidable transfer (such as from an infant, through fraud, duress, misrepresentation,etc.) are sufficient to constitute negotiation.
• Note: When an instrument is made payable to two payees with the words “to A and B”, signatures of both are required to negotiate it. Agency rules regarding actual and apparent authority apply to the indorsers.
• Discussion: Why do you think order paper requires the indorsement of a holder to negotiate the instrument? Why do you think the same rule does not apply to bearer paper? Does it surprise you that indorsement entails a certification or warranty that the paper is payable?
• Practice Question: Terry makes a promissory note that is payable to “Dan or order”. He then transfers the note to Dan. What must Dan do in order to transfer the note to Arnie?