By the term "negotiable" as applied to obligations to pay money is denoted a quality by virtue of which the obligation so described is assignable at law by the payee (and his assignees), in some cases by mere delivery and in others by indorsement, to vest in each succeeding transferee not only the legal title thereto and the direct obligation to him of the original debtor without notice to such original debtor, but when acquired under certain circumstances, such title is unaffected by the equities or defenses, if any, of such debtor against his original promisee.
A negotiable instrument is an evidence of a money indebtedness. Claims against debtors in any form are now in all jurisdictions assignable by the claimant. But such claims although assignable are not negotiable unless having certain "formal requisites" hereinafter described.
The general character of an instrument assumed to be negotiable may be indicated by the following process of reasoning.
In the first place, the fundamental idea of contract in
English and American law is that of an agreement entered into by persons who have chosen to deal with each other upon terms they have both been willing to make with full freedom to mutually regulate the manner of performance, mutually change the provisions thereof, and to oppose each to the other mutual defenses, equities and set-offs. In other words, a contract sets up an entirely personal relationship which neither party without the consent of the other can change or disturb by transferring his rights thereunder to any third person.
However, it is also recognized that a contractual right and especially a right to money cannot be of its utmost value to the claimant unless he can dispose of it to another and thereby accelerate for himself its realization. And if such transfer to another can be accomplished without overthrowing or materially impairing the fundamental idea of contract as a personal arrangement, the law ought to permit the claimant so to transfer it even without the consent of the debtor - leaving to such debtor all the rights, equities and defenses that he would have had had there been no such transfer. If a man must pay a debt arising out of contract, it cannot be material to him to whom he pays except to know that the recipient is truly entitled to it. But it is material to him that he shall not pay more than he really owes. The law therefore developed that notwithstanding the personal theory of contractual relationship, assignment of mere rights would be allowed even without the consent of the other party to the contract, but that such assignment could not carry with it any greater right than the assignor had to convey. The assignee would merely stand in the shoes of the assignor. Defenses, if any, of prior payment, non-performance of contract, fraud, duress, set-off, could be as effectually urged against the assignee as against the assignor. Furthermore such assignee must give notice that he had acquired the claim in order to make it effective against the debtor, and it became effective at the time of such notice only. Such is the law of assignment of contractual indebtedness, a law resulting as a sort of a compromise between the strict personal theory of contract and the policy of the law that what one has in the nature of an asset should be a vendible commodity; a law representing more or less of an inroad into the law of contracts, and at first reluctantly recognized.
Example 1. A, a merchant, sells his book accounts to B. One of them is an item against X for the purchase price of a machine. X must pay B under this assignment, but if he has any defense against A whether of fraud, breach of warranty, failure to get the machine, payment already, or whatever it may be, he may interpose such defense against B although B was entirely ignorant of the defense and gave full face value for the claim. Furthermore X may pay A the claim and thereby cancel the indebtedness even after the assignment unless he knows from A or B that B has acquired the claim.
But there was early felt a need in the commercial world that one's obligation to pay money, might, when the parties so desire, be made instruments of credit to bear upon their face the obligation of the debtor according to the tenor thereof, or, to state it another way, that obligations to pay money, should, so far as possible, have the characteristics of money; and this need requires that the obligation shall be separable from the transaction in which it arose and circulable as an independent and absolute obligation in itself; so that when suit is finally brought thereon by one who has acquired it, the equities, if any, between the original parties cannot be raised for adjustment against the present plaintiff. He has acquired the direct obligation of the debtor to pay to him the obligation according to the written terms, whatever may be the hidden defenses. This is contrary to the general concept of contract, and it is so because in the particular case the parties have desired it to be so, and have indicated their desire by the adoption of a form of obligation, and the law has recognized the desire and given it effect.
It is for this reason that form is so important in the law of negotiable paper, and the reason that the law says that "an instrument to be negotiable must conform to the following requirements" (which are hereinafter enumerated and considered).
Example 2. If in Example 1, X's obligation had been set forth in the form of a negotiable promissory note, B's acquisition of it (under the rules prescribed to make him a holder in due course as indicated hereafter) would make X liable to B upon the note according to its tenor, without respect to secret equities or defenses, and furthermore B would not have to give notice to X that he had acquired it in order to prevent further dealings between A and X in respect to the note. X must constantly assume that the note may have been negotiated, and therefore should not pay it except upon its presentation.
Negotiable paper in addition to being so negotiable may serve the purpose of adjusting accounts between parties without the actual transfer of funds, and, historically, that was the main reason that led to its invention upon the continent of Europe.1
I. "From these different places they [Italian bankers] corresponded with one another, and doubtless before the beginning of the thirteenth century commenced the custom of receiving money in one place to be paid out by an order upon their correspondents in another. The merchants who traveled from country to country to trade and attend the various marts and fairs were thus saved the expense and risk of transporting money in specie." - Street, Foundations of Legal Liability, Vol. 2, Ch. 31.
For instance, suppose that merchant A in the city of X has business with parties in the city of Y, and merchant B in the city of Y has business with parties in the city of X. If A and B arrange for each to accept the other's drafts upon him, funds need not pass between X and Y except upon periodical adjustment of accounts. Variations of this situation could be suggested, but the example shows the convenience of the draft or bill of exchange to perform the function mentioned.
Negotiable paper is distinguishable from other forms of simple contracts (1) in the quality of its transferability as above described, (2) in the fact that a consideration will be presumed, and (3) in the allowance of days of grace after maturity (now generally abolished).
Negotiable paper has three qualities distinguishing it from other forms of indebtedness.
(1) Transferability, as above described. This led to the following incidents:
(a) Manner of transfer, being, in certain cases, by mere delivery, and, at most, by mere indorsement of the name of the payee or other holder.
(b) Acquisition of title by transferee without necessity of notice to debtor that he has acquired it; for, being negotiable, the debtor must always bear in mind that it may have been negotiated.
(c) Title of transferee unaffected by equities, as explained above.
(d) The establishment of rules governing the transfer for the protection of all parties concerned.
(e) The additional contingent obligation of successive transferors.
(2) Consideration presumed. Even as between the original parties a consideration is presumed in the case of negotiable paper, until denied. A case is not made on other simple promises until the promisee proves the consideration. But a prima facie case is made on negotiable paper by the instrument itself.
(3) Days of Grace were allowed on negotiable paper. That is, until three days had elapsed after the paper was by its terms mature, it was not due, and suit was premature if begun before that time. But days of grace have generally been abolished and are not recognized in the Uniform Act.