BASIC PRINCIPLES OF

NEGOTIABLE INSTRUMENTS

HISTORICAL BACKGROUND OF THE NEGOTIABLE

INSTRUMENTS LAW

History records that early civilization, which had engaged extensively

in commerce, had at one time or another devised and utilized some of
negotiable instruments to facilitate business transactions. According to
available records, the oldest negotiable instrument was one made payable to
bearer approximately 2100 B.C. In Europe, negotiable instruments were
already in use in the thirteenth and fourteenth centuries and were introduced
in England approximately 1600 A.D.

The Bill of Exchange was the first recognized negotiable instrument

by the early common law courts. The Promissory Note was subsequently
declared a negotiable instrument by the Statute of Anne in 1704. Merchants
of old developed the law of negotiable instruments. It, later on, became part
of the English common law. When the American colonies broke away from
mother England in 1776, they adopted the English common law of
negotiable instruments.

Along with the territorial development and expansion of the United

States, trade increased among the States and territories to such extent that it
became imperative to adopt greater uniformity of commercial laws for
common use among the states. Thus in 1895, a conference was held in
Detroit, Michigan, wherein a resolution requesting for a draft of a uniform
Negotiable Instruments Law was approved. The result was the codification
and adoption of the Uniform Negotiable Instruments Law the following year
by all the states and territories, using as its model the English Bill of
Exchange Act.

Since the adoption of the Uniform Negotiable Instruments Law, many

changes have occurred in the financing of business transactions and in
banking practices which have brought about new and modern uses and
concepts of negotiable instruments. In some instances, it has been found out
that some provisions of the Negotiable Instruments Law were inadequate or
ambiguous, thus causing conflicts in their interpretation and application.

To keep abreast with the changes in the new business world, the
National Conference of Commissioners on Uniform State Laws and the
American Law Institute cooperated in drafting a revision of the Uniform
Negotiable Instruments Law. The revision did not involve any fundamental
changes in the Law. Rather more detailed, it clarified the existing
ambiguities, and took into consideration modern banking and financing
practices. The revised law is called the Uniform Commercial Code which
has not yet been fully adopted by all the states.

In the Philippines, the law on negotiable instruments – applied during

the Spanish and early American regimes – were the provisions of Article
443 to 566 of the Code of Commerce. These were later supplanted by Act
No. 2031 known as the Negotiable Instruments Law, enacted on February 3,
1911 and became effective on June 2, 1911. Our Negotiable Instruments
Law was patterned after the Uniform Negotiable Instruments Law of the
United States.

BASIC PRINCIPLES

DEFINITION OF A NEGOTIABLE INSTRUMENT: A negotiable

Instrument may be “A bank check, promissory note, bill of exchange, or any
other written security document that can be transferred by indorsement plus
delivery, or in some cases delivery only. The effect of this transfer is to vest
legal ownership, giving the new owner the right to demand payment of the
face amount of the instrument, long with any interest that may be due. A
bearer bond, for example, may be negotiated by delivery only, without
indorsement of the former owner.

NATURE OF NEGOTIABLE INSTRUMENTS: Basically, all

Negotiable are considered:

1. Not as Legal Tender - but merely as Provisional Payments valid to

extinguish obligations only upon conversion into actual cash. They are used
to facilitate business transactions and contracts for which negotiable
instruments are provisionally accepted in place of actual cash.

2. As Contracts – When a NI is issued by the Maker in a Promissory

Note (PN), or a Drawer in a Bill of Exchange (BE), to the Payee, there
already exists a contract between them. Then when the Payee, acting now as
Indorser, negotiates the NI to a 3rd Party, who is now as the Indorsee, there
arises another contract between them. Then again when the 3 rd
Party/indorsee indorses or negotiates the NI to another 3 rd Party, the former
becomes the Indorser and the last 3rd Party becomes the Indorsee and another
contractual relationship exists between them. In other words, there will be as
many accumulated secondary contracts as there are indorsements made is a
single NI.

PRINCIPAL FUNCTIONS OF A NEGOTIABLE INSTRUMENT:

According to Professot Beautel, there are three (3) principal functions of a
NI, i.e.:

1. As a Substitute for Money – A person can acquire goods or things

or make other business transactions involving money even if he does not
have the required cash by issuing instead a NI. Although a NI is not
considered a Legal Tender, it is acceptable as substitute for money. But as

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previously stated, a NI will not be considered a full payment as to extinguish
an obligation until it is actually converted to cash.

2. It increases Credit Circulation – An important aspect of a NI is the

extension of credit. A person may not have actual cash required to complete
a business deal, but if he is allowed to issue a NI, credit transactions may
increase as to effect world trade favorably.

3. It increases Purchasing Power in Circulation – Accepted as mode of

provisional payment and as an extension of credit in the business world, the
NI is now playing an important role in the pursuit of voluminous day to day
business transactions.

If a person is short of cash but enjoys credit facilities, then his

purchasing power is increased by enabling him to buy more items or
merchandise or transact additional business by using his credit facilities.

Suppose I go to a grocery store with PHP 1,000.00 cash.

Example: As a rule, I can purchase only PHP worth 1,000.00.

However, suppose I know the owner of the grocery store,

and he allows me to buy another PHP 1,000.00 worth of
groceries on credit, by issuing in his favor a check or
another NI.

In this case, my credit has been extended for another PHP

1,000.00 worth of groceries, and my purchasing power has
been increased from my original PHP 1,000.00 to PHP
2,000.00.

HOW IS A NEGOTIABLE INSTRUMENT NEGOTIATED AND WHO IS

CONSIDERED THE HOLDER OF THE N.I.

1. If the NI is originally an Order Instrument, it can be negotiated by

proper indorsement plus delivery.

“I promise to pay to the order of P Five Thousand Pesos

Example: (PHP 5,000.00) on demand.”

M can only negotiate the above PN to another party by

Proper Indorsement plus Delivery1.

2. If the NI is originally a Bearer Instrument it can only be negotiated

by mere delivery.

1
Please refer to Sections 34-39 NIL for the different kinds of indorsements.

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 “I promise to pay to B or Bearer Five Thousand Pesos
Example: (PHP 5,000.00) on demand.”

B can negotiate the above PN to another party by

meredelivery, meaning that after B receives the
corresponding value from the 3rd party, B negotiates it by
just delivering the NI without any additional words.

3. A Holder of the Negotiable Instrument – is one who is both the

Indorsee and possessor of the NI.

In the above examples of the Order and Bearer Instruments, the last
indorsee and possessor of the NI is considered the Holder who can collect
from the Maker or the Drawee/Acceptor on maturity date.

Other forms of NIs are the negotiable Warehouse Receipts and Bills
of Lading. They call for delivery of goods instead of payment in money.

KINDS OF NEGOTIABLE INSTRUMENT AND PARTIES

THERETO: There are three (3) representative examples of a NI, and these
are:

1. PROMISSORY NOTE2 – It is an “Unconditional promise in

writing made by one person to another, signed by the maker, engaging to
pay on demand, or at a fixed or determinable future time, a sum certain in
money to order or to bearer.”

PRINCIPAL PARTIES: Initially there are two (2) original parties to a

negotiable PN:

a. MAKER – In ordinary obligations, he is actually the debtor. In

negotiable PN, he is called the Maker, considered as the Party Primarily
Liable on the PN. He is the one who makes the unconditional promise to pay
a sum certain in money on maturity date.

b. PAYEE – He is the creditor in ordinary obligations. In the NI, he is

the party to whom the Maker must make payment on maturity. The Payee
may choose to hold the instrument until maturity date and be the one to
collect from the Maker. Or upon receipt of the PN, the Payee may negotiate
it to another 3rd party to cover another set of transaction.

The Payee and all the other succeeding indorsers are called the Parties
Secondarily Liable (PSL) to the Holder of the PN.

OTHER FORMS OF PROMISSORY NOTE –

1. Certificate of Deposit. A written acknowledgment by a bank, of a

receipt of money on deposit which the bank promises to pay to the order of
the depositor, to bearer, or to order of some specific person. To be
2
Sec. 184, NIL.

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negotiable the certificate must conform with all the requisites of a NI.
Otherwise, it becomes a mere receipt.

2. Bonds. These are more elaborate promissory notes, generally for

bigger amounts of loan payable at longer periods of time. Bonds may be
defined as a series of instruments which represents units of indebtedness and
regarded as parts of one entire indebtedness. The bond certifies that the
issuing party is indebted to the bondholder for a specific amount ro be paid
at a specific period of time at a specific period of time at a specific rate of
interest per annum.

Parties in the issue of bonds –

a. The bond issuer. This is the borrowing company who floats the
bond. The company undertakes that on maturity of the bond, it will pay the
bond-holder the amount stated therein, plus interest.

b. The bondholder. The bondholder is the purchaser of the bond and

may ask the issuing company to redeem the bond on its maturity.

c. The trustee. The trustee is the third party to whom the issuing
company has mortgaged corporate property as a security. Thus if the issuing
company cannot pay back the bondholder, the trustee will be answerable to
the latter for the value of the bond.

Forms of Bonds –

a. Debenture Bonds. These are not secured by specific property or

asset of the issuing company, but issued solely on the strength of the issuing
company’s ability to pay the debt.

b. Mortgage Bonds. These bonds are secured by a mortgage on

corporate property. Corporate property is conveyed to a trustee who will
answerable to the bondholder in case the issuer defaults in the payment of
the principal and/or interest.

c. Coupon Bonds. Attached to the bonds issued are coupon notes

representing the amount of interest payable to bearer or to the order of a
person. They may be detached and presented for payment of interest or may
be negotiated before maturity like a promissory note.

3. Due Bill. An instrument whereby one person acknowledges his

indebtedness to another and promises to pay to bearer or to order a sum
certain in money.

4. Bank Notes. These are the promissory notes of the issuing bank
which are payable to bearer on demand and intended to circulate money.
Regarded as cash and passes from hand to hand without any evidence of title
except possession.

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2. BILL OF EXCHANGE3 - It 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 or
determinable future time a sum certain in money to Order or to Bearer.”

PRINCIPAL PARTIES: There are initially three (3) parties, namely:

a. DRAWER – He is actually the debtor who draws the Bill of

Exchange requiring the Drawee to extend him credit by asking the latter to
pay the Bill to the Payee first from his own pocket and later recover from the
Drawer the amount the Drawee paid to the Payee.

b. PAYEE – He is actually the Creditor to whom the Drawee in

indebted. Payee must first collect from the Drawee who is required by the
Drawer to pay him on maturity.

c. DRAWEE – He is considered as the Party Primarily Liable on the

Bill, subject to his acceptance. The Drawee is required by the Drawer to pay
the Payee first from his own funds and recover what he has paid to the Payee
from the Drawer later on.

Pay to the order of PAYEE PHP 50,000.00 on December 31, 2013

in Bacolod City.

(Sgd.) DRAWER

TO: DRAWEE (PPL but subject to his ACCEPTANCE)

DRAWEE/ACCEPTOR = PPL

Forms of Bill of Exchange –

a. Trade Acceptance. A BE drawn by the seller of goods on the buyer

for the purchase price and is subsequently accepted by the buyer.

b. Clean Bill of Exchange. A BE to which no document is attached

when presentment for acceptance or payment is made.

3
Sec. 126, NIL.

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 c. Documentary Bill of Exchange. A BE to which supporting
documents like invoices or shipping documents are attached when
presentment for acceptance or payment is made.

d. Bank Acceptance. A draft drawn on and accepted by a bank.

e. Draft. A BE payable on demand, an order for payment of money

drawn by one individual on another.

BDO Check SM City Branch Check No. 000536

Account Name: Peter Po Date: Sept 1, 2020

Pay to the order of JOHN DE JUAN PHP 50,000.00.

(Sgd.) PETER PO

3. CHECK4 - It is “A form of Bill of Exchange drawn on a bank and always

payable on demand.”

PRINCIPAL PARTIES: There are also three parties to a Check, i.e.:

a. DRAWER – He is the person issuing the check. He must be a

depositor of the Bank, otherwise he cannot issue a check. He is requiring the
Bank to pay the Payee first out of its own funds, and then debit the drawer’s
account in the Bank.

b. PAYEE – He is the creditor of the Drawer to whom the Bank must

pay the check.

DRAWEE – The Bank where the Drawer has a deposit. The Bank is
required to pay the Payee the amount indicated in the check and later on
reimburse itself by debiting the account (deposit) of the Drawer.

RELATIONSHIP BETWEEN BANK AND DEPOSITOR –

Fixed savings and current deposits of money in banks shall be

governed by the provisions of a simple loan. The relationship between the
bank and the depositor is that of a debtor (the bank), and a creditor (the
depositor).

4
Sec. 185, NIL.

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FORMS OF CHECK –

1. Ordinary Check. An ordinary check is not a mere undertaking to

pay an amount of money. There is an element of certainty for assurance that
it will be paid upon presentation, that is why it is perceived as a convenient
substitute for currency in commercial and financial transactions; the basis of
the perception being confidence. Any practice that destroys that confidence
will impair the usefulness of the check as a currency substitute and create
havoc in trade circles and the banking community.

2. Cashier’s Check. A check drawn by a bank upon itself and payable

to third person. Persons with or without a bank account may obtain a
cashier’s check by paying the bank the equivalent amount to be covered by
the check plus a minimal service fee.

It is a primary obligation of the issuing bank and is accepted in

advance by its mere issuance. By its very nature, a cashier’s check is the
bank’s order to pay drawn upon itself, committing in effect its total
resources, integrity and honor behind the check. A cashier’s check, by its
peculiar and general use in commercial world is regarded substantially to be
as good as the money it represents.5

3. Certified Check. A personal check made by the drawer and duly

certified by the drawee bank to the effect that the bank has sufficient funds
of the drawer to cover the payment of the check when presented for
payment. The word “Certified” is stamped or written across the face of the
check and signed by the authorized officer of the bank.

4. Voucher Check. Contains a statement of the account paid by the

check and is so drawn that indorsement of the check is a receipt for the
account stated in the attached voucher.

5. Traveller’s Check. Issued by a bank to a holder who must place his

signature upon the instrument at the time it is issued, and countersigned by
the holder again before it is paid.

6. Manager’s Check. A check drawn by the manager of the bank

against the bank itself, payable to a third person.

7. Crossed Check. In order to preserve the credit worthiness of checks,

jurisprudence has pronounced that crossing of a check should have the
following effects:

a. the check may not be encashed but only deposited in the bank;

b. the check may be negotiated only once – to one who has the
account with a bank; and

5
Tan vs. Court of Appeals, GR#108555, December 20, 1994

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 c. the act of crossing the check serves as a warning to the holder that
the check has been issued for a definite purpose, so that he must inquire if he
has received the check pursuant to the purpose, otherwise, he is not a holder
in due course.6

8. Memorandum Check. It is a form of an ordinary check with the

word “Memorandum” or “Memo” written across its face signifying that the
maker or drawer engages to pay the bona fide holder absolutely, without any
condition concerning its presentment. Such check is an evidence of debt
against the drawer. Though may not be intended to be presented, it has the
same effect as ordinary check; thus, if passed to a third person, it will be
considered valid in his hands like any other check.

Distinctions among the three Negotiable Instruments –

1. As to Negotiability –

In a negotiable PN, it is unconditional promise by the maker to pay

the Payee or Holder a sum certain in money on maturity.

In a negotiable BE or a Check, the drawee/acceptor or the drawee

bank is required by the drawer to pay the Payee or Holder a sum certain in
money on maturity.

2. As to Scope of Liability –

(a) In a negotiable PN, the maker is the Party Primarily Liable, while
the Payee and the succeeding indorsers are the Parties Secondarily Liable to
the Holder of the PN.

(b) In a BE, the drawee/acceptor is the Party Primarily Liable. The

drawer, the Payee and all succeeding Indorsers are the Parties Secondarily
Liable to the Holder of the Bill.

(c) In a check, the Drawee Bank is the Party Primarily Liable and the
Drawer (depositor), the Payee, and the subsequent indorsers (if allowed by
the bank) as the Parties Secondarily Liable to the Holder.

3. Presentment for Acceptance

In a promissory note presentment for acceptance is absolutely not

necessary.

In a bill of exchange, presentment for acceptance is necessary only in

three (3) circumstances, i.e.,:7

a) When the BE is payable at a fixed period after sight.

6
Bataan Cigar & Cigarette Factory, Inc. vs. Court of Appeals, GR#93048, March 3, 1994
7
Sec. 143, NIL

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 Example:

Pay to the order of B PHP 5,000.00 thirty (30) days after sight.

The maturity date of this bill of exchange is counted 30 days from the
date of the first presentment for acceptance made by the holder to the
drawee.

b. When the place of payment of the BE is different from the domicile

of the drawee.

Example:
Pay to the order of B PHP 50,000.00 on December 31, 2020 in Bacolod City.

(Sgd.) A

TO: X, Pasig City

c. When presentment for acceptance is expressly required on the bill

of exchange.

Example:
Pay to the order of B PHP 50,000.00 on December 31, 2013. Presentment for
acceptance is required.

In all other cases, presentment for acceptance is not necessary to a

bill.

In a check, presentment for acceptance is not necessary because a

check is always payable on demand.

4. When negotiable instrument is payable on demand.8

In a PN payable on demand – presentment for payment must be made

within a reasonable time after issue.

In a BE payable on demand – presentment for payment must be made

within reasonable time after the last indorsement or negotiation.

In a Check – presentment for payment must be made within a

reasonable time after its issue.

5. In Case of Death of Parties –

8
Refer to Secs. 7 and 71, NIL

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 (a) In a Check – Drawee Bank has the authority to stop payment of the
check if it has knowledge of the death of the Drawer before payment.

(b) In both Promissory Note and Bill of Exchange, death of any

principal parties will not affect payment because of transmissibility of rights
under Art. 1178 of Obligations/Contracts.

6. In case of Forgery –

In general, under Section 23, the rule states that the party whose
signature was forged, and all the parties prior to him, will not be liable even
to a Holder in Due Course (HIDC). However, the parties after the forgery
will be liable to an HIDC as regular indorsers.

Incidents in the life of a Negotiable Instrument –

The following are the different states which a NI undergoes from the
time of its preparation to the time of its discharge.

1. Issue. Covers the period from the preparation of the instrument, either by
the maker who makes the promissory note, or the drawer who draws the BE
or check, up to the issue or delivery of the instrument to the payee.

2. Negotiation. This stage starts when the payee of the NI transfers the
instrument to another by way of negotiation through indorsement, as to
constitute the transferee the holder of the instrument. The payee becomes the
indorser and the person to whom he negotiated it is called the
indorsee/holder.

If the NI is payable to –

a) Bearer. It may be negotiated by: (1) mere delivery, or (2) by blank

indorsement plus delivery (if originally an order instrument)

b) Order. It may be negotiated by proper indorsement plus delivery.

However, if the payee or indorser makes a blank indorsement and
delivers the instrument to indorsee, the former has converted the
negotiable instrument into a bearer instrument and the holder may
further negotiate it by mere delivery.

3. Presentment for Acceptance. This step applies only to a bill of exchange

when it is payable: (a) at a fixed period after sight, or (b) at a place of
payment is different from the domicile of the drawee, or (c) when the BE
expressly requires that presentment for acceptance is required.

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 In all other BE, presentment for acceptance is not required.

4. Acceptance. A drawee under the abovementioned circumstances does not

become liable on the bill of exchange until he signifies his acceptance, and
his liability retroacts the date of the first presentment and according to the
tenor of his acceptance.9

5. Dishonor by non-acceptance. This applies only to a bill of exchange.

When the drawee refuses to accept the bill of exchange, he is said to have
dishonored the bill by non-acceptance, and the holder then acquires the right
of recourse against the parties secondarily liable, after giving a notice of
dishonor by non-acceptance to all the parties secondarily liable.

6. Presentment for payment. This applies to both PN and BE.

In a promissory note, the holder makes a presentment for payment to

the maker, the party primarily liable, on maturity date in order to collect.

In a bill of exchange, the holder makes a presentment for payment to

the drawee/acceptor, the party primarily liable in a bill of exchange, on
maturity date.10

When the negotiable instrument is payable on demand –

a) If it is a promissory note, presentment for payment must be made

within a reasonable time after issue.

b) If it is a bill of exchange, presentment for payment must be made

within a reasonable time after the last indorsement.

7. Dishonor by non-payment. This likewise applies to both promissory note

and bill of exchange. If the maker in a promissory note, or the
drawee/acceptor in a bill of exchange refuses to pay the instrument on
maturity date for whatever reason, the instrument is dishonored by non-
payment, and the holder has the right to recourse against the parties
secondarily liable by giving them notice of dishonor by non-payment.

In a promissory note, the parties secondarily liable are the payee and
all the indorsers prior to the holder. The maker is the party primarily liable.

In a bill of exchange, the parties secondarily liable are the drawee, the
payee, and all the indorsers prior to the holder. The drawee/acceptor is the
party primarily liable.

8. Discharge. The negotiable instrument is discharged under Section 119 by-

a) payment in due course by or on behalf of the principal party;

9
Refer to Secs. 62 and 136, NIL.
10
Refer to Sec. 71, NIL.

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 b) payment in due course by the party accommodated, where the
instrument is made or accepted for accommodation;

c) intentional cancellation thereof by the holder;

d) any other act which will discharge s simple contract for payment of
money;

e) merger or confusion.

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