Understanding Negotiable Instruments and Payment Systems

Negotiable instruments such as checks do away with the need to carry cash.

A negotiable instrument is a piece of paper, such as a promissory note or a bank draft, that confers the right to receive money on the holder of the paper. Historically, the need for these sorts of instruments developed as overseas trade and commerce took off in the 14th century. This created a need for merchants to move large sums of money without taking on the risk of carrying it on their person.

Draft

A bank draft, also known as a bill of exchange, is a negotiable instrument that is made out by a drawer. The drawer obliges the party on whom the draft is drawn, called the drawee, to pay the person who presents the draft a sum of money mentioned in the draft. The person to whom the money is to be paid is the payee. The money is usually payable at a certain point of time. It could also be payable when the payee presents the draft.

Promissory Note

A promissory note is made out by a person who promises to pay another person a certain sum of money. The note serves as evidence that one person owes another person money and has promised to pay it at some point of time. The person who receives the promissory note could wait until its due date to collect the money. Or if she wants the money earlier, she could pass on the note to a third party who will pay her the money, less a commission. The third party will then collect the money when it is due.

Checks

Checks are another form of negotiable instrument. A check could be a personal check, drawn by an individual on a bank to fulfill a payment obligation, or it could be a bank check issued by a bank to provide greater security to the payee. There are also traveler's checks that travelers use to avoid carrying cash while overseas. The person who writes a traveler's check should countersign the check while using it to make payments. This makes the checks more likely to be accepted since the receiver can verify that the payer's signature matches the original signature on the check.

Requisites for Negotiable Instruments

Only instruments that meet certain requirements qualify as negotiable instruments. For one, they should be signed in writing. The promise to pay the money specified on the instrument should be unconditional. It should not be dependent on a certain event happening. The money to be paid should be a fixed amount and should be payable to the bearer of the instrument or to his assignee. The money should be payable on presentation of the instrument or at a fixed time.

References

• Lexisnexis: Understanding Negotiable Instruments and Payment Systems, William H. Lawrence
• Google books: Payment Systems by Lary Lawrence