Negotiable Instruments

Question 1

What are the two types of debt?

Answer 1

Debts fall into two broad categories:

1) Demand debts
⁃ A debt which is payable on demand (i.e. whenever the creditor wishes)
⁃ A typical demand debt is an overdrawn bank account - the bank is entitled to reclaim the sum due on demand.

2) Term debts
⁃ A term debt is one which is payable on a term expiry.
⁃ A typical term debt is a secured finance to buy a house.

Question 2

Can you sell debts?

Answer 2

Yes - If you have a term debt this means you are owed money in the future. However you may want cash now. So the holder of the term debt can sell the debt to receive cash now.

Question 3

What are the two ways you can sell debts?

Answer 3

In selling debts you can do so in one of two ways:
⁃ 1) Sub participation
⁃ 2) Assignation

Question 4

What is Sub participation?

Answer 4

E.g. A lent money to B over 10 years. A wants cash now. A sells the debt to a financier who pays cash to A. In sub participation, B has no idea that A has entered into this transaction with the financier - B continues under an obligation to pay A and only A. The financier has given cash subject to an undertaking from A that when B pays, A will transmit that payment on to the financier.

Question 5

What are the risks of sub-participation to the financier?

Answer 5

There are two main risks
⁃ 1) A goes insolvent
⁃ If this happens the financier ends up with a personal right under the contract to get payment in the insolvency of A, but all the payments are still due to A and will be paid into the liquidation. And typically A will have more creditors than just the financier.
⁃ So what does the financier do to protect their position?
⁃ In invoice discounting in Scotland, the financier requires the seller of the debts to hold the payments in trust. So A must become a trustee for the financier as beneficiary. The advantage of this arrangement is that if you have a beneficial interest in the asset that takes priority over unsecured creditors in the insolvency of the trustee (A) because the trust asset is held in a separate patrimony.
⁃ [NB the trust will contain two types of property: the proceeds when they are paid and rights to payment (as incorporeal property).]
⁃ 2) B goes insolvent
⁃ The risk that B goes insolvent is something that the financier will take into account when deciding how much to pay for the debt.
⁃ The reduction in the face value of the debt to the amount that is paid is called the discount - this is often known as invoice discounting and is often used by businesses that have cash flow problems.

Question 6

How can you sell debts by assignation?

Answer 6

This is the ‘orthodox’ practice - but will almost never be used in practice because it is so complicated (because intimation to every debtor would be required of the financier). As a result, sub-participation will be used instead.

Question 7

What are the disadvantages of the assignation of debts?

Answer 7

There are also disadvantages to the assignee in this situation:
⁃ The principle assignatus utitur jure auctoris broadly means that the assignee steps into the shoes of the creditor and therefore any defences good against the original creditor are also good against the assignee (this means any defences to payment of the debt will also bind the buyer of the debt). The buyer of the debt does have some protection because of the warrandice debutum subesse between the assignor and the assignee (a guarantee that the debt is still legally payable, but there is no implied guarantee that the debt will actually be paid).

⁃ As a result of these disadvantages, this is why negotiability was introduced.

Question 8

What is a negotiable instrument?

Answer 8

“An instrument is a document of title to money. … [I]t is the physical embodiment of the payment obligation, and its possession (with any necessary indorsement in favour of the possessor) is the best evidence of entitlement to the money it represents. The right to receive payment belongs to the holder for the time being, is exercised by production of the instrument to the oblige or his authorized agent and is transferred by delivery, with any requisite indorsement.”

An instrument  is corporeal document which contains (houses or embodies) an obligation (an incorporeal right from the creditors point of view). [Similar to the abstract theory of transfer in property law - whether or not there are problems with the underlying contract is irrelevant, it it the conveyance itself which is important.]

Although there is no all encompassing definition of negotiable - for an instrument to be negotiable it must have two key features ⁃	1) be capable of simple transfer  ⁃	2) be able to be transferred free from equities (defects in title of its predecessor)

Question 9

What does it mean when we say a negotiable instrument is a document embodying a debt distinct from an underlying obligation?

Answer 9

As a bill of exchange is a document embodying a debt that is readily transferable it can have an abstract existence from the initial reason for an underlying obligation arising.
⁃ For example, Alf wishes to buy 1,000 widgets from Bert. Bert sells the widgets and agrees to accept payment in the form of a negotiable instrument from Alf. Bert and Alf have certain mutual obligations arising under the Sale of Goods Act 1979. However, liability there is distinct from the Alf’s liability under the negotiable instrument. It is sometimes helpful, therefore, to consider the liability on the negotiable instrument as being wholly distinct from any underlying agreements between the parties (Although as we will later see this is something of an oversimplification).

Question 10

How do bills operate in practice?

Answer 10

⁃ They typically arise in relation to international trade like in CIF contracts are ‘cost, insurance and freight’ contracts.
⁃ In these contracts the seller agrees to sell the goods, arrange for the transportation of the goods and arrange insurance of the goods. Because the seller is incurring all these upfront costs in relation to insurance etc will want a way to try to obtain their cash as quickly as possible. So from the seller’s perspective they want a negotiable instrument. They will draw up a bill of exchange for the buyer to pay them [the seller]. The buyer will accept and sign the bill of exchange [but in practice, only on condition that they get the insurance documents assigned to them and the carriage documents (bill of lading)]. The moment the seller has this bill of exchange they will sell it on a financial market because this will give them cash now. From the perspective of the financier, it is attractive for them to buy because they know that they don’t need to worry about any underlying contract - the bill of exchange will be paid regardless.

Question 11

What are the three types of negotiable instrument?

Answer 11

Under the Bills of Exchange Act 1882 there are 3 broad types of bills of exchange:

(1) Promissory note
⁃ A two party bill of exchange - where one party promises to make payment to X. (e.g. a bank note).
⁃ The person who incurs the note is called the ‘maker’ of the note. The person to whom payment is made is the ‘payee’.

(2) Bill of exchange - drafts.
⁃ In theory a three party document. One person gives an order for payment (drawer) to be made to another person who is ordered to make payment (drawee). That person who is ordered to make payment is ordered to make payment to an identified individual (payee).
⁃ The drawer, the drawee and the payee remain constant throughout the entire transaction - they do not change as the bill of exchange is sold from one person to another. They are the people who are identified on the bill of exchange at the start when it is written.

(3) Cheque (sometimes).
⁃ Three party bills of exchange where the person who writes the cheque (the drawer) are giving an instruction to their bank (the drawee) to make payment to a payee.

Question 12

How can bills of exchange loans be divided?

Answer 12

In the same way that loans can be divided into term and demand loans, bills of exchange can be divided into time bills and demand bills.

Question 13

What is a time bill?

Answer 13

A time bill is a bill which is payable after the passage of a period of time. Also known as tenor bills or usance bills.
⁃ Sometimes time bills will tell you exactly what day to pay on
⁃ Sometimes time bills will tell you to pay in X number of days, or X number of days ‘after sight[ When a time bill provides that it is to be payable after sight, it is providing that the date on which the bill becomes payable is to be determined by the date on which the drawee accepts the bill.]’

Question 14

What is a demand bill?

Answer 14

A demand bill
⁃ A demand bill is a bill of exchange which is payable on demand. Sometimes known as a sight bill. If no date is mentioned then it is a demand bill.
⁃ Bank notes are demand promissory notes.

Question 15

What is a Bill of Exchange?

Answer 15

Bills of exchange are defined in the Bills of Exchange Act 1882, s 3(1):
⁃ ‘A Bill of Exchange is an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed and determinable future time a sum certain in money to or to the order of a specified person, or to bearer’.

Question 16

What are the requirements for a Bill of Exchange?

Answer 16

The bills of exchange must be:

⁃ 1) An unconditional order
⁃ Thus a bill of exchange must be an order and it must be unconditional.
⁃ An order will require some instruction to be given to the addressee e.g. “pay” or “please pay” is sufficient.
⁃ It must be unconditional - a bill of exchange under the 1882 Act cannot e.g. require that money comes from a particular place. The moment that a condition is added this removes the bill from being within s 3 of the 1882 Act and thus disapplying the whole of the 1882 Act.

⁃ 2) In writing
⁃ Thus electronic bills of exchange are not possible however there is no requirement that you use a particular form, as long as there is a corporeal presence [it could be written on the side of a cow and still be valid].

⁃ 3) Addressed by one person (drawer) to another (drawee)
⁃ The drawer and drawee remain the same people throughout the life of the bill - the drawer is the person who gave the order and the drawee the person to whom the order is given.
⁃ The drawer is typically named in the bottom right hand of the bill and the drawee in the bottom left of the bill.

4) Must be signed by the drawer
⁃ This is a broad principle in relation to bills of exchange that if you sign bills of exchange then you become liable on it. This is provided for under s 23. Under s 23(2) a partner can sign a bill on behalf of the entire partnership.

5) Payable on demand or at a determinable time
⁃ In order for the bill to be valid the event on which the bill is payable must be a thing which will definitely happen. If it is something that might not happen then it will not be a valid bill of exchange.
⁃ One can also state a bill of payable after period of time “after sight”. This means the date on which the bill of exchange has been accepted by the drawee. See section 14: the day of acceptance is day zero and you begin counting 1 from the following day.
⁃ [In a question where they ask when payment is to be made make sure to actually calculate the date if dates are given (see (d) for tutorial 6).]

6) A sum certain in money
⁃ It doesn’t matter what currency a bill is in - a bill of exchange can be in any currency.
⁃ It must be a determinable sum of money. This doesn’t preclude the possibility of there being interest but it precludes there being a fluctuating interest rate.

7) Payable to a specified person or the bearer
⁃ The person to whom the bill is payable is known as the payee.
The payee remains constant and are identified on the front of the bill of exchange. The person who is intimately entitled to payment may end up not being the payee and the bill can convert from being an order bill into a bearer bill and back again but the payee remains the same. The person who is entitled to payment is called the holder.

Question 17

Can the drawer and drawee be the same person?

Answer 17

Yes. In effect you are ordering yourself to make payment - if you order yourself to make payment then the payee is entitled to treat the bill of exchange as a promissory note (since it is equivalent to a promissory note where on person is promising a sum of money to pay).

Question 18

What happens if the drawee does not exist?

Answer 18

The bill of exchange is treated as a promissory note (s 5(2): “where in a bill drawer and drawee are the same person, or where the drawee is a fictitious person or a person not having capacity to contract, the holder may treat the instrument, at his option, either as a bill of exchange or as a promissory note.”)

Question 19

What is a signature?

Answer 19

A pre-printed signature is sufficient (e.g. bank notes). Similarly a stamp signature is a valid signature.

Question 20

What form must the signature take?

Answer 20

The RW(S)A 1995 does not apply formally to bills of exchange - but if you follow the requirements in the Act then your signature will definitely be valid.

Question 21

What are the difficulties surrounding agency?

Answer 21

⁃ The agent must make explicit on the bill that they are acting as an agent. If it is not clear then s 23 indicates that the person who signs is personally liable.
⁃ Section 26 provides that where a person signs as drawer, endorser or acceptor and adds words to his signature indication that he signs for and on behalf of[ The simplest way to make sure you avoid personal liability is to write “for and on behalf of”.] a principle, he is not personally liable - the principal incurs liability. But the mere addition to signature of words describing him as an agent or representative does not exempt him from personal liability.

⁃ e.g.
⁃ 1) AB, Director, X Ltd: this would be treated as being merely a description of AB and they would thus be personally liable.
⁃ 2) X Ltd, AB, Director - this indicates that AB is signing on behalf of the company as an agent and thus the company is liable, not AB.

Question 22

What happens if there is a forged signature on the Bill?

Answer 22

Section 24 governs the situation where there is a forged signature on a bill of exchange. It states that where there is a forged signature on a bill of exchange, this signature is not valid.
⁃ But if you are a third party down the line and the bill has been traded and the people don’t know that it is a forged signature, and you then sign the bill as acceptor / endorser, then you can potentially become liable:
⁃ If the drawer’s signature is forged, under s 54 if you accept the bill (as drawee, by signing across the front) you cannot deny the genuineness of the drawer’s signature to anyone who demands payment subsequently.

Question 23

What are the two types of payees?

Answer 23

There are two types of payees:

1) Bearer bills
⁃ This is a bill which states ‘pay bearer’. A bearer bill is payable to the person who has possession of the bill.

2) Order bills
⁃ This is a bill which names a payee - e.g. “Pay Fred”. Fred is the payee.

Question 24

What happens if the payee doesn’t exist?

Answer 24

Under s 7, where the payee is fictitious or non existing the bill is treated as being a bearer bill.

Question 25

Bank of England v Vagliano Brothers [1891]

Answer 25

There was a fictitious payee who did exist. There was a clerk working for a particular business and he drafted the bills of exchange for the business. He knew that when he took the bills of exchange through to be signed they didn’t really check them - they just signed them. He decided to write bills of exchange for a foreign business that they’d done trade with in the past and write this name as the payee. Because the name was known to the directors they just signed the bill. The clerk would then sell the bill on the open market and nobody would eventually demand payment of the bill because the payee didn’t exist. The court treated the payee as fictitious even though it was actually a real company because there was never any intention that there be a valid payee. So the bill was treated as a bearer bill which means that since the company had signed the bill it became liable and the person who has possession of the bill could demand full payment from the company.

Question 26

Why is acceptance of a Bill of Exchange necessary?

Answer 26

Acceptance is necessary for two reasons.
⁃ Firstly, acceptance determines the date on which the bill is payable.
⁃ Secondly acceptance is necessary because it makes the drawee liable on the bill.

Question 27

How is a bill presented for acceptance?

Answer 27

For a bill to be accepted it must be presented for acceptance. Under s 41 the procedure for presenting a bill for acceptance is set out. Presentment for acceptance is made by the holder of the bill. The payee is the first holder of the bill and if the payee has transferred it onto a third party through endorsement of the bill then the endorsee can become the holder of the bill.

Question 28

When is a bill presented for acceptance?

Answer 28

Section 40 provides that a bill must be presented for acceptance within a reasonable time.

Question 29

Who is a bill presented to?

Answer 29

The bill must be presented to the drawee.

Question 30

What happens if the drawee doesn’t sign?

Answer 30

If a drawee doesn’t sign then they are perfectly entitled to refuse to sign. What happens then?
⁃ When a bill is presented for acceptance and it is not accepted by the drawee it is called dishonouring the bill by non-acceptance. When a bill is dishonoured, the people who have already signed the bill become liable on it. At this point only the drawer will have signed the bill. There is a possibility that before the bill has been presented for acceptance the payee may have transferred the bill on to a third party and so the drawer is going to incur liability to that third party.
⁃ Dishonour by non-acceptance requires notices of dishonour to be served by the holder of the bill to all the people they want to preserve a right of payment against. Not sure what this means