University of Southern Philippines Foundation

College of Accountancy
Salinas Drive, Lahug, Cebu City

Regulatory Framework for Business Transactions January 26, 2020

Negotiable Instruments Law Atty. J.M. Denila, CPA

Negotiable Instruments - Is a written contract for the payment of money which complies with the requirements
of Section 1 of the Negotiable Instruments Law, which by its form and on its face is intended as a substitute for
money and passes form hand to hand as money, so as to give the holder in due course (HDC) the right to hold the
instrument free from defenses available to prior parties.

Two Distinctive Features of Negotiable Instruments (NI):

1. Negotiability- it is that attribute or property whereby a bill or note or check may pass form hand to hand
similar to money, so as to give the holder in due course the right to hold the instrument and to collect the
sum payable for himself free from defenses.

2. Accumulation of Secondary Contracts- secondary contracts are picked up and carried along with them as
they are negotiated from one person to another, or in the course of negotiation of a negotiable
instrument, a series of judicial ties between the parties thereto arise either by law or by privity.

Function of Negotiable Instruments:

1. As a substitute of money
2. As a means of creating and transferring credit
3. It facilitates sale of goods
4. It increases the purchasing medium in circulation.

Classes of Negotiable Instruments:

1. PROMISSORY NOTE- unconditional promise in writing by one person to another, signed by the maker,
engaging to pay on demand, or at a fixed or determinable time a sum certain in money to order or to
bearer.

2. BILL OF EXCHANGE- an unconditional promise 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
determinable future time a sum certain in money to order to a bearer.

Promissory Notes Bill of Exchange

Unconditional promise Unconditional order
Involves 2 parties Involves 3 parties
Maker is primarily liable Drawer is only secondarily liable
Only one presentment: for payment Two presentments:
for acceptance and payment.

REQUISITES OF NEGOTIABILITY (Sec. 1)

(W)1. It must be in writing and signed by the maker or drawer;
(U) 2. Must contain an unconditional promise or order to pay a sum certain in money;
(P) 3. Must be payable on demand, or at a fixed or determinable future time;
(O)4. Must be payable to order or to bearer; and
(A)5. Where the instrument is addressed to a drawee, he must be named or otherwise indicated therein
with reasonable certainty.

The validity and negotiable character of a NI are not affected by the fact that:
1. It is not dated; or
2. Does not specify the value given; or that any value has been given therefor; or
3. Does not specify the place where it is drawn or the place where it is payable; or
4. Bears a seal; or
5. Designates a particular kind of current money in which payment is to be made.
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UNCONDITIONAL PROMISE OR ORDER

- where the promise or order is made to depend on a contingent event, it is conditional, and
the instrument involved is non-negotiable. The happening of the event does not cure the defect.

The unconditional nature of the promise or order is not affected by:

a) An indication of a particular fund out of which reimbursement is to be made, or a particular account

to be debited with the amount; or
(b) A statement of the transaction which gives rise to the instrument.

But an order or promise to pay out of a particular fund is not unconditional.

Fund for Reimbursement Particular Fund for Payment

Drawee pays the payee form his own funds; There is only one act-the drawee pays
afterwards, the drawee pays himself from directly from the particular fund indicated.
the particular fund indicated. Payment is subject to the condition that the
fund is sufficient
Particular fund indicated is NOT the direct Particular fund indicated is the direct source
source of payment but only the source of of payment
reimbursement
Does not affect the unconditional nature of Makes the promise or order conditional
the promise or order

CERTAINTY OF SUM

The sum is certain if the amount is fixed. The certainty however is not affected although to be paid:
a. With interest; or
b. By stated installments; or
c. By stated installments, with a provision that, upon default in payment of any installment or of interest,
the whole shall become due; or
d. With exchange, whether at a fixed rate or at the current rate; or
e. With costs of collection or an attorney's fee, in case payment shall not be made at maturity.

PAYABLE IN MONEY

General Rule: If some other act is required other than or in addition to payment of money, the instrument is
not negotiable.

Exceptions:
a) Authorizes the sale of collateral securities in case the instrument be not paid at maturity; or
b) Authorizes a confession of judgment if the instrument be not paid at maturity; or
c) Waives the benefit of any law intended for the advantage or protection of the obligor; or
d) Gives the holder an election to require something to be done in lieu of payment of
money. e) Allows the creditor the option to require something in lieu of money.

PAYABLE ON DEMAND

An instrument is payable on demand —

a) Where it is expressed to be payable on demand, or at sight, or on presentation; or
b) In which no time for payment is expressed.
c) Where an instrument is issued, accepted, or indorsed when overdue, it is, as regards the person
so issuing, accepting, or indorsing it, payable on demand.
DETERMINABLE FUTURE TIME

An instrument is payable at a determinable future time which is expressed to be payable

(a) At a fixed period after date or sight; or
(b) On or before a fixed or determinable future time specified therein; or
(c) On or at a fixed period after the occurrence of a specified event, which is certain to
happen, though the time of happening be uncertain.

PAYABLE TO ORDER
- The instrument is payable to order where it is drawn payable to the order of a specified person or to
him or his order.
- Where the instrument is payable to order, the payee must be named or otherwise indicated therein
with reasonable certainty.

PAYABLE TO BEARER

The instrument is payable to bearer —

(a) When it is expressed to be so payable; or
(b) When it is payable to a person named therein or bearer; or
(c) When it is payable to the order of a fictitious or non-existing person, and such fact was known to the
person making it so payable; or
(d) When the name of the payee does not purport to be the name of any person; or
(e) When the only or last indorsement is an indorsement in blank.

NOTE: An instrument originally payable to bearer can be negotiated by mere delivery even if it is
indorsed specifically. If it is originally a BEARER instrument, it will always be a BEARER instrument.

As opposed to an original order instrument becoming payable to bearer, if the same is indorsed specifically, it
can NO LONGER be negotiated further by mere delivery, it has to be indorsed.

REAL DEFENSES
- Those which attach to the instrument itself and are available against all holders, whether in
due course or not.

Examples:
1. Alteration
2. Incomplete and undelivered instrument
3. Duress amounting to forgery
4. Forgery
5. Minority
6. Ultra vires act of a corporation, where the corporation is absolutely prohibited by its charter from
issuing any commercial paper under any circumstances
7. Want of authority of agent
8. Illegality of contract

PERSONAL DEFENSES
- Those which are available only against a person not a holder in due course or a subsequent holder
who stands in privity with him.

Examples:
1. Absence or failure of consideration, partial or total
2. Complete but undelivered instrument
3. Incomplete and delivered instrument
4. Mistake
5. Negotiation in breach of faith
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EFFECTS OF DEFENSES:

A. Effects of Incomplete but Delivered Negotiable Instruments (Sec. 14)

1. Holder has prima facie authority to fill up the instrument.
2. Completion within reasonable time and according to authority; and
3. HDC can enforce such despite deficiency

B. Effect of Incomplete and Undelivered Negotiable Instruments (Sec. 15)

- If completed and delivered without authority, not a valid contract against a person who has signed
before delivery of the contract even in the hand of HDC but subsequent indorsers are liable.

Problem:

A signed a blank check and kept it inside the drawer of his desk in his office. B, a janitor of the office opened the
drawer, got the check and filled in the amount of P100,000 with B’s name as payee. Thereafter, B indorsed the
check to C and C indorsed the check to D. Should the drawee bank dishonor the check, can D hold A liable? Would
your answer be the same if D was a holder in due course? How about B and C, are they liable to D?

Answer:

No, D cannot hold A liable because the instrument is incomplete and undelivered. Under Section 15 of NIL, an
incomplete and undelivered instrument would not be a valid instrument in the hands of any holder as against any
person whose signature was placed before delivery.

Yes, my answer will be the same even if D is a holder in due course because the law says “any holder”.

Yes, B and C are liable. B is liable because he was the forger and besides as indorser, he warrants that the
instrument is genuine and in all respects what it purports to be. So also, with C.

C. Effects of Complete but Undelivered NI (Sec. 16)

1. Between immediate parties and a remote party not a HDC, delivery to be effectual must be authorized.
2. As to HDC, all prior deliveries are conclusively presumed valid; and
3. If the instrument is not in the hands of drawer/maker, valid and intentional delivery is
disputably presumed.

Effects of Absence or Failure of Consideration (Sec. 28)

Personal defense to the prejudiced party and available against any person not HDC.

FORGERY (Sec. 23)

Forgery under Section 23 applies to :

1. Where the signature on the instrument is affixed by one who does not claim to act as an agent and who
has no authority to bind the person whose signature he has forged;
2. Where the signature is affixed by one who purports to be agent but has no authority to bind the alleged
principal.
Effects:
- Signature (not instrument itself and subsequent indorsers) is wholly inoperative, and no right
to retain the instrument, or to give a discharge therefor, or to enforce payment thereof against
any party to it, is acquired through or under such signature UNLESS the party against whom it is sought
to enforce such right is precluded from setting up forgery or want of authorit
 Persons precluded from setting up defense of forgery:

1. Those who warrant to admit the genuiness of the signature in question. This includes indorsers, persons
negotiating by delivery and acceptors.

2. Those who, by their acts, silence or negligence are estopped from setting up an defense of forgery.

F. Material Alteration

- Any change in the instrument which affects or changes the liability of the parties in any way.
Effects:
1. Alteration by a party

Material alteration avoids the instrument except as against the party who made, authorized, or assented to the
alteration and subsequent indorsers.

However, if an altered instrument is negotiated to a HDC, he may enforce payment thereof according to
its original tenor regardless or whether the alteration was innocent or fraudulent.

2. Alteration by a stranger (spoliation)

The effect is the same as where the alteration is made by a party, that a HDC can recover on the original tenor of
the instrument.

Is the alteration of the serial number of a check a material alteration?

No. The alteration of the serial number of the check does not alter the effect of the instrument, nor does it modify
in any respect the obligation of a party thereto. It does not change the items which are required to be stated in
Section 1, NIL.

CONSIDERATION

Presumption of Consideration

Every NI is deemed prima facie to have been issued for a valuable consideration. Every person whose signature
appears thereon is presumed to have become a party thereto for value.

Valuable Consideration

In general, it is said to consist either in some right, interest, profit or benefit, accruing to the party who makes the
contract, or some forbearance, detriment, loss, responsibility, act, labor, or service on the other side.

Problem:

A bill of exchange was issued because of the love and affection of the drawer to the payee. Can the drawer be held
secondarily liable (assuming non-acceptance by the drawee) on the instrument (a) by the payee; and (b) by the
holder in due course?

Answer:

a. No. The drawer cannot be held secondarily liable by the payee because while the love and
affection may be a good consideration, it is not valuable consideration.
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b. Yes, a holder in due course can hold the drawer secondarily liable. Want or absence of consideration is only a
personal defense and cannot be raised against a holder in due course.

ACCOMODATION
- A legal arrangement under which a person called the accommodation party lends his name
and credit to another called the accommodated party, without any consideration.
Requisites:
1. The accommodation party must sign as maker, drawer, acceptor, or indorser;
2. No value is received by the accommodation party from the accommodated party; and
3. The purpose is to lend the name or credit.

Effects:
- The person to whom instrument thus executed is subsequently negotiated has a right of recourse
against the accommodation party in spite of the former’s knowledge that no consideration has
passed between the accommodation and accommodated parties.

Liability of the Accommodation Party

- Liable on the instrument to a holder for value notwithstanding such holder at the time of the taking
of the instrument knew him to be only an accommodation party.

NEGOTIATION
- The transfer of a NI form one person to another as to constitute the transferee the holder thereof.
- If the NI is payable to bearer, it can be negotiated by delivery
- If the NI is payable to order, it can negotiated by the indorsement of the holder completed
by delivery.

INDORSEMENT

Legal transaction effected by the writing of one’s own name at the:

a. back of the instrument; or
b. upon a paper (allonge) attached thereto with or without additional words specifying to whom or
to whose order the instrument is to be payable whereby one not only transfers legal title to the
paper transferred but likewise enters into a implied guaranty that the instrument will be
duly paid.

GR: Indorsement must be of the entire instrument

EXC: Where the instrument has been paid in part, it may be indorsed as to the residue.

KINDS OF INDORSEMENT

1. Special Indorsement
- A special indorsement specifies the person to whom, or to whose order, the instrument is to
be
payable; and the indorsement of such indorsee is necessary to the further negotiation of the instrument.

2. Blank Indorsement

One which specifies no indorsee:

a. instrument payable to bearer and may be negotiated by delivery
b. may be converted to special indorsement by writing over the signature of the indorser in blank
any contract consistent with the character of the indorsement

3. Conditional Indorsement
- Right of the indorsee is made to depend upon the happening of a contingent event. Party paying
may disregard the conditions.
 4. Restrictive Indorsement

An indorsement is restrictive; which either —

(a) Prohibits the further negotiation of the instrument; or
(b) Constitutes the indorsee the agent of the indorser; or
(c) Vests the title in the indorsee in trust for or to the use of some other persons.

But the mere absence of words implying power to negotiate does not make an indorsement restrictive.

5. Qualified Indorsement
- Constitute the indorser a mere assignor of the title to the instrument. Words like “sans recourse”,
“without recourse”, etc.

STRIKING OUT INDORSEMENT

- The holder may at any time strike out any indorsement which is not necessary to his title.
The indorser whose indorsement is struck out, and all indorsers subsequent to him, are thereby
relieved from liability on the instrument.

HOLDER IN DUE COURSE

- A holder in due course is a holder who has taken the instrument under the following conditions:
(a) That it is complete and regular upon its face;
(b) That he became the holder of it before it was overdue, and without notice that it had been previously
dishonored, if such was the fact;
(c) That he took it in good faith and for value;
(d) That at the time it was negotiated to him, he had no notice of any infirmity in the instrument or defect in
the title of the person negotiating it.

RIGHTS OF A HOLDER IN DUE COURSE

1. may sue thereon in his own name;
2. may receive payment and payment to him in due course, discharges the instrument.
3. holds the instrument free from any defect of title of prior parties, and free from defenses available to
prior parties among themselves
4. may enforce payment of the instrument for the full amount thereof against all parties liable thereon.

LIABILITIES OF PARTIES

1. Parties Primarily Liable

a. MAKER
i. engages to pay according to the tenor of the instrument; and
ii. admits the existence of the payee and his capacity to indorse

b. ACCEPTOR OR DRAWEE
i. engages that he will pay it according to the tenor of his acceptance;
ii. admits the existence of the drawer, the genuineness of his signature, and his capacity and authority
to draw the instrument; and
iii. admits the existence of the payee and his then capacity to indorse.

2. Parties Secondarily Liable

a. DRAWER
a.i. admits the existence of the payee and his then capacity to indorse
 a.ii. engages that, on due presentment, the instrument will be accepted or paid, or both, according
to its tenor;
a.iii. engages that if it be dishonored and the necessary proceedings on dishonor be duly taken,
he will pay the amount thereof to the holder or to any subsequent indorser who may be compelled to
pay it.

b. GENERAL INDORSER

i. Warrants:
1. that the instrument is genuine and in all respects what it purports to be;
2. that he has a good title to it;
3. that all prior parties had capacity to contract; and
4. that the instrument is valid and subsisting

ii. engages that, on due presentment, the instrument will be accepted or paid, or both, according to its tenor;

ii. engages that if it be dishonored and the necessary proceedings on dishonor be duly taken, he will pay the
amount thereof to the holder or to any subsequent indorser who may be compelled to pay it.

c. IRREGULAR INDORSER- a person not otherwise a party to an instrument places his signature thereon, in blank
before delivery.

ii. If the instrument is payable to the order of a third person, he is liable to the payee and to all
subsequent parties.
iii. If the instrument is payable to the order of the maker or drawer, or is payable to bearer, he is liable to all parties
subsequent to the maker or drawer.
iv. If he signs for the accommodation of the payee, he is liable to all parties subsequent to the payee.

DISCHARGE OF INSTRUMENT
- A release of all parties, whether primary or secondary, form the obligations arising thereunder. It renders the
instrument without force and effect and, consequently, it can no longer be negotiated.

WHEN A NEGOTIABLE INSTRUMENT IS DISCHARGED

(a) By payment in due course by or on behalf of the principal debtor;
(b) By payment in due course by the party accommodated, where the instrument is made or accepted
for accommodation;
(c) By the intentional cancellation thereof by the holder;
(d) By any other act which will discharge a simple contract for the payment of money;
(e) When the principal debtor becomes the holder of the instrument at or after maturity in his own right.

WHEN A PERSON SECONDARILY LIABLE IS DISCHARGED

a) By any act which discharges the instrument;
(b) By the intentional cancellation of his signature by the holder;
(c) By the discharge of a prior party;
(d) By a valid tender of payment made by a prior party;
(e) By a release of the principal debtor, unless the holder's right of recourse against the party
secondarily liable is expressly reserved;
(f) By any agreement binding upon the holder to extend the time of payment, or to postpone the holder's right
to enforce the instrument, unless made with the assent of the party secondarily liable, or unless the right of recourse
against such party is expressly reserved.