Legal Definitions - words of negotiability

Words of negotiability are specific phrases or terms included in certain financial documents, such as checks or promissory notes, that make them easily transferable from one person or entity to another. These words are essential for a document to be considered a "negotiable instrument" under the law, meaning it can be passed along like money itself, often without the need for a formal assignment of rights.

The most common words of negotiability are:

• "Pay to the order of": This indicates that the instrument is payable to a specific person or entity, who can then endorse it (sign the back) to transfer it to someone else.
• "Pay to bearer" or "Pay cash": This means the instrument is payable to whoever possesses it, making it freely transferable by simple delivery.

Here are a few examples to illustrate this concept:

• Example 1: A Personal Check

  Imagine Sarah writes a check to her landlord, Mr. Henderson, for her monthly rent. The check states, "Pay to the order of Mr. Henderson."

  This phrase, "order of," is a word of negotiability. It means Mr. Henderson can either deposit the check into his own bank account or, if he wished, he could endorse it over to a third party (for instance, if he owed money to a contractor, he could sign the back of the check and write "Pay to the order of [Contractor's Name]"). The check's negotiability allows it to move through the financial system as a transferable form of payment, rather than being restricted solely to Mr. Henderson.

• Example 2: A Promissory Note for a Loan

  Suppose a small business, "Innovate Tech," borrows $50,000 from an investor, Ms. Chen, and issues a promissory note. The note includes the language, "Innovate Tech promises to pay $50,000 to the order of Ms. Chen on December 31st."

  The phrase "order of" here makes the promissory note a negotiable instrument. If Ms. Chen later needs immediate cash, she could potentially sell or transfer this note to another investor or a bank before its due date. The new holder would then have the legal right to collect the $50,000 from Innovate Tech when it matures, without needing a complex legal assignment process, because the note itself is designed to be transferable.

• Example 3: A Certificate of Deposit (CD)

  Consider a bank issuing a Certificate of Deposit (CD) that states it is "payable to bearer on maturity."

  In this scenario, the word "bearer" is the word of negotiability. It means that whoever physically possesses the CD at its maturity date is entitled to redeem it for the principal amount plus interest. This makes the CD easily transferable by simple delivery; the original purchaser could sell or give the CD to someone else, and that new holder would become the rightful owner without needing any formal endorsement or change of registration with the bank, as long as they are the "bearer."