III. THE USE OF CREDIT INSTRUMENTS IN

TRANSFERRING WEALTH

A share of stock is a written evidence of ownership that is, partial ownership-of a designated business. The possessor of a share is in effect a joint owner of certain definite, tangible wealth, although in the nature of the case he is debarred from taking possession of such wealth without the consent of other shareholders. The owner of a bond or promissory note or accepted draft has a partial claim against definite, tangible wealth that is owned by others. Under present conditions, where industry is primarily organized on the corporate basis, and where capital, both fixed and working, is largely borrowed, these ownership shares and creditor claims represent a very considerable proportion of the total wealth of the world.

A business, the capitalization of which runs into millions of dollars, is seldom sold outright. Its shares and bonds constantly change hands, however, and there is an ever-shifting body of shareholders and creditors. Similarly, the evidences of borrowed working capital in the form of promissory notes and bills of exchange are continually being transferred through the process of purchase and sale. Indeed, a large corporation does not usually even know who its creditors are, either the owners of its bonds or the holders of its notes and acceptances; it merely knows that a certain total amount of claims against it are "floating" somewhere in the investment and commercial markets.

In the preceding chapter we have seen that the marketability of bonds and shares greatly facilitated the raising of capital. A ready marketability is equally important with short-term promissory notes and bills of exchange. The essential point is that if one were not able to extricate himself from a financial relationship, if he could not regain command of his funds at will, he would be less willing to make loans either for fixed or working capital purposes. We shall find that, by virtue of the development of certain legal principles, these credit instruments have also come to be extensively used as a means of transferring the ownership of wealth.

Salability and transferability. Three legal principles have been developed to facilitate the use of credit instruments in transferring the ownership of wealth: namely, salability, transferability, and negotiability. The various forms of credit instruments-bonds, shares, notes, drafts, checks, certificates of deposit, etc.-possess these attributes in varying degrees, and it appears that, consciously or unconsciously, each has been given the particular attributes required by the nature of the use to which it has been found convenient to devote it.

On the matter of salability a word of explanation will be sufficient. By means of a sale an individual may transfer to another all of his ownership rights in a piece of property. The law of sales has been made applicable to all of these credit instruments; and an owner of one of them may therefore always transfer to another at least the same amount of ownership of the instrument, and thus of the property which the instrument represents, that he himself possesses.

While salability is an obvious prerequisite to the transferability of any of these instruments, it does not fully explain the latter. For instance, a credit instrument, unlike tangible personal property, may be automatically transferred by the mere process of indorsement, that is, by writing one's name on the back of an instrument that is made payable to him or to his order; or, in the case of an instrument made payable to bearer, it may be transferable merely by delivery, that is, by passing it on to another. Similarly, an instrument that has been indorsed in blank, that is, by the owner's writing his name on the back of it without designating any specific payee, is also transferable by mere delivery. The ease with which these instruments may be transferred renders their use as a means of exchanging the ownership of wealth much more general than would otherwise be the case.

But transferability may involve more than this. For even though he himself has no title at all, a possessor of an instrument that is payable to bearer may transfer to another a valid or unimpeachable title. A bearer instrument is thus for all practical purposes equivalent to money. But this borders on

the principle of negotiability, to a consideration of which we may now turn

The principle of negotiability. A negotiable instrument possesses the attribute of salability, and its title is transferable from one person to another, either by indorsement or by delivery. But it has other attributes as well. As usually defined, a negotiable instrument differs from a simple contract, or "chose in action," in that a "bona fide purchaser for value," innocent of any irregularity as between the original parties to the contract, obtains a title to the instrument that is free from all personal defenses and equities of prior parties. A purchaser of a nonnegotiable instrument, however, takes the instrument subject to all its original defenses and is apparently supposed to protect himself by an investigation of the origin and history of the instrument. While there are some exceptions to this principle, while transferability with a better title is not an exclusive attribute of a negotiable instrument, it nevertheless possesses this attribute in a very high degree; and it is commonly said to be its distinctive characteristic.

In order to possess the quality of negotiability, an instrument must conform to certain requirements prescribed by the custom of merchants-now codified in the law of negotiable instruments. The instrument must be drawn up in a certain prescribed form, it must be sold in a specified manner, certain precise steps must be followed in presenting it for payment, and a definite procedure must be gone through in giving notice of its dishonor in case of non-payment.' These requirements originally related only to commercial credit instruments in the form of promissory notes and bills of exchange, and the history of the law of negotiability is associated with commercial, rather than investment, credit instruments.

The law governing negotiable instruments had its inception in the customs of the mercantile world; they were born of the necessities and needs of merchants, as is indicated by the fact that the law relating to such instruments is usually known

For details see pp. 175–78.

2

as "the law merchant." The custom of making such notes and bills of exchange payable to order or bearer arose in England early in the seventeenth century. But until 1756, when Lord Mansfield, "the father of the law merchant," expressed and molded into the form of definite rules of law the numerous customs that had grown up among merchants in connection with these instruments, the law of bills and notes was in a more or less chaotic condition. Mansfield made the law merchant an integral part of the great body of the English law, which was inherited by the American colonies, and in due course by the American commonwealths.

During the first century of American legal history, differing interpretations of the law merchant developed in the various states, with the result that commercial practice was seriously handicapped. About 1890, however, a movement was initiated to bring about a codification of the law merchant, with a view to securing uniformity in the various jurisdictions. A negotiable instruments bill was finally drafted in 1896 by a mittee on commercial law," and this has since become a law in nearly every state in the Union, in a few instances, however, with more or less important modifications.

The reason for developing the principle that an instrument in the hands of an innocent third party should be free from personal defenses and collateral claims existing between prior parties was to facilitate the use of such an instrument as a means of making payment. In the settlement of transactions between merchants at the great fairs and market places in early England there was plenty of occasion for irregularities. For instance, the maker of an instrument might have entered

'While originating in mercantile lines, these instruments are now used quite as much by manufacturers as by merchants.

'Promissory notes and bills of exchange appear to have been used by various nations of antiquity. There are records of their use in Babylonia and Syria, in Athens and in Rome. It appears, indeed, that by the time of Justinian the fundamental principles of the bill of exchange and the promissory note were pretty well developed. After the Dark Ages we find them arising again with the trading operations of Italian cities; and by the middle of the thirteenth century the bill of exchange had apparently become a common document.

I

into the transaction without consideration, and if a third party were asked to accept an instrument subject to such defense as an original maker might set up, he would usually refuse because of the risks involved. Accordingly, it was necessary to devise a means whereby the purchaser of such an instrument would be protected from irregularities of which he could have no cognizance without a careful investigation of the origin and history of the instrument in question.

To be negotiable, an instrument must meet certain essential conditions. In order to guard against misinterpretation, fraud, etc., the law prescribes that an instrument to be negotiable must be drawn up in a certain definite way. The conditions that must be met to make an instrument negotiable are as follows:

1. It must be in writing. No oral contract could be negotiable. A written contract may be either in writing or in printing, and the writing may be executed with any substance, as ink or pencil.

2. It must be properly signed. It is usual that the signature be made by writing in full the name of the signer; but a mark or any other character intended to be the signature will suffice. The signature is usually placed at the close of the instrument, although if it is clear that it is meant for a signature it may be placed on any part of the instrument.

3. It must be negotiable in form, that is, payable to order or bearer. It must be clearly shown to be the intent of the party making the instrument to execute a negotiable paper; and to make this intent clear there must be some expressed words showing such a purpose.

4. It must be payable in money only. The reason for this requirement is to insure the amounts being certain and definite. By the term "money" is meant the legal tender of the country.

5. The amount must be certain. The sum payable is considered fixed and certain if it is a definitely stated amount with interest, or in stated instalments, or with exchange (the bank's charges for collection), or with the cost of collection in case. payment is not made at maturity.

'See pp. 177-78.