MODULE LAW ON NEGOTIABLE INSTRUMENTS

CHAPTER 3-NEGOTIATION

Learning Objectives:

1. Define negotiation
2. Differentiate the different modes of negotiation.
3. Understand the rights of a holder
4. Differentiate the characteristics of holder in due course.
5. Understand the defenses against the holder.

I. NEGOTIATION

When is an instrument negotiated?

An instrument is negotiated when it is transferred from one person to another in

such a manner as to constitute the transferee the holder thereof. (Sec. 30)

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Note: A holder is the payee or indorser of a bill or note, who is in possession of it, or the
bearer thereof. (Sec. 191)

What are the methods of transferring a negotiable instrument?

1. Issue – first delivery of the instrument complete in form to a person who takes it as
a holder.
2. Negotiation – an instrument is negotiated when it is transferred from one person to
another in such a manner as to constitute the transferee the holder thereof.
3. Assignment – absent any express prohibition against assignment or transfer written
on the face of a non‐ negotiable instrument, the same may be assigned or
transferred.

II. DISTINGIUSHED FROM ASSIGNMENT

What distinguishes negotiation from assignment?

NEGOTIATION ASSIGNMENT

Only a negotiable instrument may be Non-negotiable may be assigned absent of

negotiated any prohibition against assignment written
on its face.

The transferee, if he is a HIDC may The transferee can have no better rights
acquire better rights than his transferor. than his transferor; he merely steps into
the shoes of the assignor.

The holder can hold the drawer liable and The transferee has no right of recourse for
the indorsers liable if the party primarily payment against immediate parties.
liable does not pay.

III. MODES OF NEGOTIATION

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What are the methods of negotiation?

1. If payable to bearer‐ it is negotiated by delivery

2. If payable to order‐ it is negotiated by the indorsement of the holder completed by
delivery. (Sec. 30)

What is the effect, if any, if a bearer instrument is negotiated by indorsement and

delivery?

A bearer instrument, even when indorsed specially, may nevertheless be further

negotiated by delivery, but the person indorsing specially shall be liable as endorser to
only such holders as make title through his endorsement (once a bearer instrument,
always a bearer instrument). (Sec. 40)

Note: This rule does not apply to an instrument originally payable to order but is
converted into bearer instrument because the only or last indorsement is an indorsement
in blank.

Earl Louie makes a promissory note payable to bearer and delivers the same
to Joana. Joana, however, endorses it to Ana in this manner:

"Payable to Ana. Signed: Joana."

Later, Ana, without indorsing the promissory note, transfers and delivers the
same to Batista. The note is subsequently dishonored by Earl Louie. May Batista
proceed against Earl Louie for the note?

Yes. Earl Louie is liable to Batista under the promissory note. The note made by
Earl Louie is a bearer instrument. Despite special indorsement made by Joana thereon,
the note remained a bearer Instrument and can be negotiated by mere delivery. When Ana

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delivered and transferred the note to Batista, the latter became a holder thereof. As such
holder, Batista can proceed against Earl Louie. (1998 Bar Question)

Where indorsement should be placed?

1. On the instrument itself; or

2. On a separate piece of paper attached to the instrument called “allonge”. (Sec. 31)

Can there be partial indorsement?

 GR: No. Indorsement must be of the entire instrument. (Sec. 32)

 XPN: When there is partial payment.

What is the effect when an order instrument was delivered without indorsement?

The transfer operates as an ordinary assignment (Sec.49). Without the

indorsement, the transferee would not be the holder of the instrument. When indorsement
is subsequently obtained, the transfer operates as a negotiation only as of the time the
negotiation is actually made.

Note: The transferee has the right to require the transferor to indorse the
instrument.

What is the effect when a negotiable instrument is merely assigned?

The transferee does not become a holder and he merely steps into the shoes of the
transferor. Any defense available against the transferor is available against the transferee.
(Salas v. CA, G.R. No. 76788 Jan. 22, 1990)

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What is an indorsement?

Indorsement is the writing of the name of the indorser on the instrument with the
intent to transfer title to the same.

What are the different kinds of Indorsement?

1. Special (Sec. 34)–Specifies the person to whom or to whose order the instrument is
to be payable. Also known as specific indorsement or indorsement in full.
2. Blank (Sec. 34) –Specifies no indorsee.
a. Instrument is 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 indorsement
(Sec. 35).
3. Absolute–The indorser binds himself to pay
upon no other condition than failure of prior parties to do so upon due notice to him
of such failure.

4. Conditional –Right of the indorsee is made to depend on the happening of a contingent

event. Party required to pay may disregard the conditions (Sec. 39)

5. Restrictive –When the instrument:

 Prohibits further negotiation of the instrument (it destroys the negotiability of the
instrument);
 Constitutes the indorsee the agent of the indorser; (Sec. 36)
 Vests the title in the indorsee in trust for or to the use of some persons. But mere
absence of words implying power to negotiate does not make an instrument
restrictive.

6. Qualified (Sec. 34) – constitutes the indorser a mere assignor of the title to the
instrument. It is made by adding to the indorser’s signature words like, without recourse
(serves as an ordinary equitable assignment) (Sec. 38)

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7. Joint–indorsement made payable to 2 or more persons who are not partners. (Sec. 41)

Note: All of them must indorse unless the one indorsing has authority to indorse for
the others

8. Irregular (Sec. 64) – A person who, not otherwise a party to an instrument, places
thereon his signature in blank before delivery.

9. Facultative–Indorser waives presentment and notice of dishonor, enlarging his liability

and his indorsement.

10. Successive – indorsement to two persons in succession.

Note: Any of them can indorse to effect negotiation of the instrument.

What is the effect of a qualified indorsement:

A qualified indorsee has limited liability. He is liable only if the instrument is

dishonored by non‐ acceptance or non‐payment due to:

Forgery;

 Lack of good title on the part of the indorser;

 Lack of capacity to indorse on the part of the prior parties; or
 The fact that at the time of the indorsement, the instrument was valueless or not
valid at the time of the indorsement which fact was known to him.

Note: A qualified indorser guarantees only the genuineness of the instrument but does not
guarantee its payment.

What are the rights of an indorsee in a restrictive indorsement?

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1. To receive payment of the instrument;

2. To bring any action thereon that the indorser could bring; and
3. To transfer his rights as such indorsee, where the form of the indorsement
authorizes him to do so. (Sec. 37)

What do subsequent indorsees acquire under the restrictive indorsement?

All subsequent indorsees acquire only the title of the 1st indorsee. (Sec. 37)

When there is a joint indorsement, who must indorse?

1. GR: All must indorse in order for the transaction to operate as a negotiation. (Sec.
41)
2. XPN:
 Payees or indorsees are partners; and
 Payee or indorsee indorsing has authority to indorse for the others.

What are the instances where the indorsements served only as equitable
assignment?

1. Indorsement of part of the amount of the instrument. (Sec. 32)

2. In cases of qualified indorsement. (Sec. 38)
3. Conditional Indorsement. (Sec. 39)
4. Transfer of an instrument payable to order by mere delivery. (Sec. 49)

When can an indorsement be stricken out?

The holder may, at any time, strike out any indorsement which is not necessary to
his title. Indorser whose indorsement is struck out, and all indorsers subsequent to him,
are relieved from liability on the instrument. (Sec. 48)

When can a prior party negotiate an instrument?

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Where an instrument is negotiated back to him. But, he is not entitled to enforce

payment thereof against any intervening party to whom he was personally liable. (Sec. 50)

What are the limitations to renegotiation?

1. In the following cases, a prior party cannot further negotiate the instrument:
2. Where it is payable to the order of a third person, and it has been paid by the
drawer (Sec. 121[a]);
3. Where it was made or accepted for accommodation and has been paid by the party
accomodated(Sec. 121[b]);
4. In other cases, where the instrument is discharged when acquired by a prior party.
(Sec. 119)

IV. RIGHTS OF A HOLDER

Who is a holder?

The payee or indorsee of a bill or note who is in possession of it or the bearer

thereof. (Sec. 191)

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What are the classes of holders?

1. Holders in general (Simple Holders). (Sec. 51)

2. Holders for value. (Sec. 26)
3. Holders in due course. (Secs. 52, 57)

What are the rights of a holder in general?

1. Right to sue
2. Right to receive payment (Sec. 51)

Note: If the payment is in due course, the instrument is discharged.

V. HOLDER IN DUE COURSE

What constitutes payment in due course?

When made:

1. At or after the maturity of the instrument

2. To the holder thereof, in good faith and without notice that his title is defective (Sec.
88)

Who is a holder in due course (HIDC)?

1. He who takes a negotiable instrument:

2. That is complete and regular upon its face;
Note: Absence of the required documentary stamp will not make the instrument
incomplete. (It is not a requisite of negotiability under Sec. 1 and it is not a material
particular under Sec. 125)

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3. Became the holder before it was overdue, and without notice that it has been
previously dishonored, if such was the fact;
Note: if the instruments is payable on demand, the date of maturity is determined
by the date of presentment, which must be made within a reasonable time after its
issue, if it is a note, or after the last negotiation thereof, if it is a bill of exchange.
(Secs. 71 and 143[a])
4. Where transferee receives notice of any infirmity in the instrument of defect in the
title of the person negotiating the same before he had paid the full amount agreed
to be paid, he will be deemed a holder in due course only to the extent of the
amount paid by him. (Sec. 54)
5. Took it in good faith and for value;
6. 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. (Sec. 52)
Note: Knowledge of the agent is constructive knowledge to the principa

Who is deemed to be a HIDC?

 GR: Every holder is deemed prima facie to be a holder in due course;

 XPN: When it is shown that the title of any person who has negotiated the
instrument was defective. (Sec.59)

Can a payee be a HIDC?

There can be no doubt that a proper interpretation of NIL as a whole leads to the
conclusion that a payee may be a holder in due course under the circumstances in
which he meets the requirements of Sec. 52. (De Ocampo v. Gatchalian, G.R. No.
L‐15126, Nov. 30, 1961)

Note: There is a contrary view on the matter, wherein it is contended that under
subsection 4 of Sec. 52, the holder in due course must have acquired the instrument
through negotiation and an instrument is issued and not negotiated to a payee.

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Can a drawee be a HIDC?

A drawee does not by paying a bill become a holder in due course since a holder
refers to one who has taken the instrument as it passes along in the course of
negotiation; whereas a drawee, upon acceptance and payment, strips the instrument of
negotiability and reduces it to a mere voucher or proof of payment.

What are the rights of a HIDC?

1. Hold the instrument free from defenses available to parties among themselves
2. Hold the instrument free from any defect of title of prior parties
3. Receive payment
4. Enforce payment of the instrument for the full amount thereof against all parties
liable
5. Sue

Who is a holder not in due course (HNIDC)?

1. One who became a holder of an instrument without any of the requisites under
Sec. 52
2. One to whom an instrument payable on demand is negotiated after an
unreasonable length of time from issue. (Sec. 53)

What are the rights of a HNIDC?

1. The rights similar to an assignee. The other rights are:

2. He may receive payment and if the payment is in due course, the instrument is
discharged
3. He is entitled to the instrument but holds it subject to the same defenses as if it
were non‐negotiable
4. He may sue on the instrument in his own name. (Sec. 5)

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What are the rights of a holder through a HIDC?

He has all the rights of a HIDC from whom he derives his title in respect of all
parties prior to such holder, provided he is not himself a party to any fraud or illegality
affecting the instrument. (Sec. 58)

Note: A payee or indorsee whose title is defective cannot better it by selling the
instrument to a HIDC and buying it again. Similarly, a HIDC who negotiates the
instrument to a holder other that one in due course and then reacquires it will hold the
instrument as a holder in due course.

How does the “shelter principle” embodied in the Negotiable Instruments Law
operate to give the rights of a HIDC to a holder who does not have the status of a
HIDC? Briefly explain.

Under the shelter principle, a person who does not qualify as a holder in due
course can, nonetheless, acquire the rights and privileges of a holder in due course if he
derives his title to the instrument through a holder in due course. However, a person
who previously held the instrument cannot improve his position by later reacquiring it
from a holder in due course if the former holder was a party to fraud or illegal activity
affecting the instrument or had notice of a claim or defense against the instrument.
(2008 Bar Question)

When is the title of a person (transferor) defective?

1. In its acquisition – When he obtained the instrument, or any signature thereto, by

fraud, duress, or force and fear, or other unlawful means, or for an illegal
consideration.
2. In the negotiation – When he negotiates it in breach of faith, or under such
circumstances as amount to a fraud. (Sec. 55)

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What constitutes notice of defect (on the transferee)?

The person to whom it is negotiated must have had actual knowledge of such
facts or knowledge of other facts that his action in taking the instrument amounted to
bad faith. (Sec. 56)

What is the effect of notice before the full amount is paid?

Transferee will be deemed a holder in due course only to the extent of the
amount therefore paid by him. (Sec. 54)

The drawer delivered a check to Wilma, an agent, for safekeeping only and for the
purpose of evidencing her sincere intention to buy a car owned by RC, who is
Wilma’s principal. Wilma did not return the check and delivered it as payment for
her hospital expenses to MB Clinic. Does the presumption that every holder is
presumed to be HIDC apply to MB Clinic?

No, the rule that a possessor of the instrument is prima facie a HIDC does not
apply to MB Clinic because there was a defect in the title of the holder, since the
instrument was not payable to WILMA or to bearer, the drawer had no account with the
payee, Wilma did not show or tell the payee why she had the check in his possession
and why he was using it for the payment of his own account. As holder’s title was
defective or suspicious, it cannot be stated that the payee acquired the check without
knowledge of said defect in holder’s title, the presumption that it is a HIDC does not
exist. (De Ocampo& Co. v. Gatchalian, G.R. No. L‐15126, Nov. 30, 1961)

NSW received three post‐dated and crossed checks issued on the condition that
the drawer on due date would make sufficient deposits to cover the checks. NSW
did not wait for the maturity and indorsed the check to an investment house,

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which deposited the same. The checks bounced. Is the investment house a
holder in due course?

No, that the checks had been issued subject to the condition that the drawer on
due date would make the backup deposit for said check which condition was not made,
constitutes a good defense against the holder who is not a HIDC, particularly when the
check was crossed. The crossing of a check serves a warning to the holder that the
check had been issued for a definite purpose so that he must inquire if received the
check pursuant to that purpose, otherwise, he is not a holder in due course. (State
Investment House v. IAC, G.R. No. 72764, July 13, 1989)

What is the effect of possession of a negotiable instrument after presentment and

dishonor?

It does not make the possessor a holder for value within the meaning of the law.
It gives rise to no liability on the part of the maker or drawer or indorsers. (STELCO
Marketing Corp. vs. CA, G.R. No. 96160, June 17, 1992)

Is a corporation to which four crossed checks were indorsed by the payee

corporation a holder in due course and hence entitled to recover the amount of
the checks when the same had been dishonored for the reason of “payment
stopped”?

The checks were crossed checks and specifically indorsed for deposit to payee’s
account only. From the beginning, the corporation was aware of the fact that the checks
were all for deposit only to payee’s account. Clearly then, it could not be considered a
HIDC. However, it does not follow as a legal proposition that simply because it was not
a HIDC for having taken the instruments in question, w/ notice that the same was for
deposit only, that it was altogether precluded from recovering on the instrument. The
disadvantage in not being a HIDC is that the negotiable instrument is subject to

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defenses as if it were non‐negotiable. (Atrium Management Corp. v. CA, G.R. No.

109491, Feb. 28, 2001)

VI. DEFENSES AGAINST THE HOLDER

What are the defenses against the Holder?

1. Real Defenses – those that are available against all parties, both immediate and
remote, including holders in due course.
2. Personal Defenses –defenses which are not available against a holder in due
course. Those which grow out of the agreement or conduct of a particular person
in regard to the instrument which renders it inequitable or though holding the
legal title, to enforce it against the party sought to be made liable.

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REFERENCE:

Law on Negotiable Instruments

Author: Hector S. De Leon
Hector S. De Leon, Jr.

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