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================================================= Material Negotiability in English Law:

Historical Re-Examination of Commercial Paper Circulation Free From Claims and Defences*

By

Benjamin Geva Professor of Law, OHLS, York University, Toronto Canada

bgeva@osgoode.yorku.ca

Paper presented at the IACCL, Toronto bi-annual meeting, July 2010 1. Introduction

‘Negotiability’ consists of two elements. First, it signifies transferability by

delivery (with or without endorsement), which is referred to as ‘transferability with a certain facility’ or ‘procedural negotiability’. Second, ‘negotiability’ addresses the transferor’s power to thereby confer on the transferee a better title than that of the transferor; this is referred to as ‘transferability free from equities’ or ‘material negotiability’.1

* This paper is part of a study on the legal history of the payment order for which funding has been provided by a Major Research Grant awarded by the Social Science and Humanities Research Council of Canada (SSHRCC), whose support I acknowledge with gratitude. 1 See DV Cowen & L. Gering, Cowen on the Law of Negotiable Instruments in South Africa 5th ed., Volume I: General Principles (Cape Town: Juta, 1985) at 31-36.

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The holder who is not the direct promissee on the instrument, namely, usually,2 either an endorsee of an instrument payable to order or a ‘remote’ bearer of an instrument payable to bearer, may benefit from each of the two elements of ‘negotiability’ in a different way. Thus, it is ‘procedural negotiability’ which confers on the holder the right to sue, that is, the standing to bring an action, on the instrument he holds. In turn, it is however ‘substantive negotiability’ which usually3 guarantees to the holder the right to recover from a party liable on the instrument the full amount thereon. ‘Material negotiability’ thus complements ‘procedural negotiability’. However, ‘material negotiability’ has not sprung automatically out of ‘procedural negotiability’. Conceptually, while ‘material negotiability’ cannot exist without ‘procedural negotiability’, the reverse is not true, so that ‘procedural negotiability’ can exist on its own, without generating ‘substantive negotiability’.4

The difference between the two elements of negotiability can be demonstrated by

reference to Hinton’s Case (1682)5. The case involved a bill payable to J.S. or bearer. In his judgement, Pemberton CJ ruled that a bearer seeking to recover from the drawer of that bill, ought to “intitle himself to it on a valuable consideration … for if he come to be bearer by casualty or knavery, he shall not have the benefit of it”.6 In Grant v. Vaughan (1764),7 Lord Mansfield explained Pemberton CJ to say in Hinton’s Case (1682) “that the [bearer’s] action would lie, if [he] came by the bill of exchange honestly and on a valuable consideration”.8 It appears then, that Lord Mansfield does not deny the impact of ‘procedural negotiability’, namely, the standing of the bearer to sue on the instrument even when he came “to be bearer by casualty or knavery”; nevertheless, to succeed in his action, Lord Mansfield would require the bearer to rely on ‘material negotiability’, that is, on the fact that he “came by the bill of exchange honestly and on a valuable consideration”.

2 There are ‘unusual’ circumstances, as for example of a bank draft issued to a remitter to the order of his creditor, in which the payee is not an ‘immediate’ party to a transaction with the party who issued the instrument. Such circumstances are outside of the scope of the present discussion. 3 Certainly, there is a narrow range of defences, based on the ineffectiveness altogether of the instrument, which are available even against a holder in due course. Such defences are outside of the scope of the present discussion. 4 5 2 Show. K.B. 235, 89 E.R. 911. 6 Ibid. Grammatically, the “it” may refer either to the bill or the action. 7 3 Burr. 1516, 97 E.R. 957. 8 Ibid. at 1521 (Burr.), 959. (ER).

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Each of the ensuing parts will set out the development of one of the two

components of ‘material negotiability’. The first aspect is the holder’s freedom from third-party’s adverse claims to the instrument. The second is the holder’s freedom from contract defences of a party liable on it. The cumulative effect of both freedoms is the enforceability by the holder of the instrument to the entire amount payable, over both challenges to his proprietary right to the instrument, and contract defences purporting to extinguish or reduce the liability of a party thereto. 2. Freedom from adverse claims According to Fox,9 as a legal attribute,

“Currency allows the title in money to be renewed whenever the money passes to a person who receives it in good faith and in return for a valuable consideration. The recipient’s title is freshly created. It is good against the whole world, which means that the recipient can acquire a better title than the transferor had.”

Stated otherwise, the effect of the currency feature of money, which may also be referred to as the currency rule, is to confer on the bona fide for value payee a good title, and extinguish adverse property claims such as prior ownership. Thus, having been out of possession of money, whether by losing it or being the victim of robbery or theft, the owner’s title is defeated by a good faith taker for value who derive his title from the finder or thief. Another way to put is to say that the maxim nemo dat quod non habet does not apply to money, so that the finder or thief can confer on the taker in good faith and for value a better title than the finder or thief has. The first aspect of ‘material negotiability’ corresponds to ‘currency’. A leading case is Anon. (1699).10 The case involved a “bank bill”11 payable to a payee or bearer. The instrument was lost by payee; it was found by a stranger, who “assigned it”, that is, delivered it, to the plaintiff- bearer “upon a valuable consideration”. Plaintiff presented the instrument and received payment from the bank in the form of “a new bill in his own name”. In a terse judgment, Lord Holt concisely set out the relative rights of the parties to the original instrument. In his view, in the facts of the case, the payee

9 D. Fox, “Bona Fide Purchase and Currency of Money”, 55 (1966) Cambridge LJ 547, at 547. 10 Anon. (1699), 3 Salk. 71, 91 E.R. 698. 11 According to Fox, above note 9 at 560, this was a “ sealed Bank of England bill”. However, Holden, JM Holden, The History of Negotiable Instruments in English Law (London: University of London: The Athlone Press, 1955, rep. 1993, WM. W. Gaunt & Sons) at 91 describes the instrument as “a Bank of England note.”

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“may have trover against the finder, for [the finder] had no title, though a payment to him had indemnified the bank; but not against [the assignee/bearer], because of the consideration, which, by course of trade, creates a property in the assignee or bearer”12

Subsequently, more than 50 years later, the point was confirmed by Lord Mansfield in Miller v. Race (1758).13 This was an action in Trover14 by a bona fide purchaser for value of a stolen Bank of England note payable to bearer. The defendant was the Bank of England’s clerk who had acted on the instructions of the dispossessed original owner15 and upon the presentment of the note for payment had refused to either honour or return the note to the plaintiff. Effectively, the Court was called upon to determine the relative rights of the plaintiff and the dispossessed original owner, from whom the defendant had purported to derive his right. In ruling in favour of the plaintiff, Lord Mansfield recognized the effect of the plaintiff’s good faith purchase for value to extinguish the property right of the dispossessed original owner. In the course of his judgment, Lord Mansfield explained the nature of bearer Bank of England notes as follows:

“Now they are not goods, not securities, nor documents for debts, nor are so esteemed: but are treated as money, as cash, in the ordinary course and transaction of business, by the general consent of mankind; which gives them the credit and currency of money, to all intents and purposes. They are as much money, as guineas themselves are; or any other current coin, that is used in common payments, as money or cash.”16

In Lord Mansfield’s view, the treatment of banknotes as money was the determinative factor in allowing plaintiff to recover to the detriment of the dispossessed original owner whose rights had been extinguished. This is so since

“money can not be followed … upon account of the currency of it: it can not be recovered after it has passed in currency. So in case of money

12 Above note 10 at 71 (Salk.), 698 (E.R.). Emphasis added. 13 (1758), 1 Burr. 452, 97 E.R. 398. 14 For Trover and Conversion, see CHS Fifoot, History and Sources of the Common Law: Tort and Contract, (London: Stevens & Sons, 1949) at 102-125 15 More specifically, the original owner sent the banknote by mail. However, that night the mail was robbed and the banknote was taken and carried away by the robber. Plaintiff bought it next day “for a full and valuable consideration, and in the usual course of his business, and without any notice or knowledge of this bank note being taken out of the mail”. Above note 13 at 452 (Burr.), 398 (E.R.). 16. Ibid. at 457 (Burr.), 401 (E.R.).

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stolen, the true owner can not recover it, after it had been paid away fairly and honestly upon valuable consideration: but before money has passed in currency an action may be brought for the money itself”17

An obiter of Lord Holt in Ford v. Hopkins (1700)18 is cited by Fox19 in support of the contrary position in relation to banknotes. Indeed, in this case, Lord Holt drew a distinction between “money or cash” that cannot be distinguished on one hand and banknotes on the other hand; the latter, having “distinct marks and numbers on them”, are distinguishable.20 Certainly, this appears to be inconsistent with Lord Holt’s own view in Anon. (1699).21 Fox explains away the contradiction between the two cases by suggesting that between both, only Ford v. Hopkins (1700) involved banknotes, and that Lord Holt did not treat notes to be negotiable.22 However, it is possible, and it is in fact so argued by Holden,23 that also Anon. (1699) involved a banknote. Moreover, Lord Holt challenged the negotiability of notes, possibly other than banknotes, and certainly, only where they were payable to order;24 there is no indication of a challenge by him to the negotiability of banknotes, or notes in general, payable to bearer. What is then the explanation to Ford v. Hopkins (1700)?25 In his judgment in Miller v. Race (1758) Lord Mansfield expressed the view that Lord Holt must have been misunderstood so that his judgment in Ford v. Hopkins (1700) was not correctly reported.26 However, in my view there may be a simpler explanation to the apparent contradiction which thus resolves it; it could indeed well be that in Ford v. Hopkins (1700) Lord Holt was pointing out to a physical difference between coins and banknotes but did not address the position of a bona fide purchaser of value thereof. However, upon

17 Ibid. at 457-458 (Burr.), 401 (E.R.) 18 (1700), 1 Salk 283, 91 E.R. 250. 19 Fox above note 9 at 561. 20 Above note 18 at 284 (Salk.), 251 (E.R.) 21 Above note 10, and see ensuing discussion there setting out Lord Holt’s view. 22 Fox, above note 9 at 561-562. 23 Holden, above note 11 at 91. 24 25 Above note 18. 26 Above note 13 at 459 (Burr.), 402 (E.R.).

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reflection, in the final analysis, it is likely that in distinguishing in Ford v. Hopkins (1700) between coins and banknotes, Lord Holt was pointing out at a legal distinction that exists notwithstanding their common currency feature. Thus, in the case of loss or theft of money, the lack of distinguishing marks in coins does not facilitate their following into the hands of a third party; at the same time, it is precisely the existence of distinguishing marks in banknotes that facilitates their following into the hands of a third party. However, notwithstanding the broad language in Ford v. Hopkins (1700), stating that the owner of stolen or lost banknotes may “bring an action into whatsoever hands they are come”, and that banknotes “cannot be reckoned as cash”,27 this distinction between coins and banknotes matters only insofar as the third party does not qualify as an innocent purchaser for value. Indeed, it was observed in Hartop v. Hoare (1743)28 that this broad language by Lord Holt must be narrowed down to “mean that the owner can bring an action for them, into whatsoever hands they come without a valuable consideration paid for them.”29 Conversely, where the third party in possession of banknotes qualifies as a their good faith purchaser for value, notwithstanding the broad language in Ford v. Hopkins (1700), per Lord Holt’s own statement in Anon. (1699), the currency quality confers title on the third party, also to banknotes, “because of the consideration, which, by course of trade, creates a property in the [innocent] assignee or bearer.”30 In Miller v. Race (1758), in providing for the currency of money, Lord Mansfield was dismissive of the view under which “the reason why money can not be followed is, because money has no ear-mark.”31 It seems however, and notwithstanding Lord Mansfield to the contrary, lack of ear-mark appears to be the true explanation to the currency of coined money in English law.32 Unlike Jewish law, English law did not develop a legal doctrine explaining the currency of coins.33 Rather, prior to Miller v. Race (1758), lost or stolen coins passed from

27 Above note 18 at 284 (Salk.), 251 (E.R.) 28 3 Atk. 44, 26 E.R. 828. 29 Ibid at 50 (Atk.), (E.R.) 832. Emphasis in the original. 30 Above note 10 at 71 (Salk.), 698 (E.R.). 31 Above note 13 at 457 (Burr.), 401 (E.R.). 32 Fox above note 9 at 449-554. 33 For ‘currency’ under the Talmud, see B. Geva, “The Monetary Legal Theory Under the Talmud” (2008), 55 RIDA (Revue Internationale Des Droits de l'Antiquité), 13, 34-37.

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hand to hand free of claims of the previous owners simply because they lacked identifying signs, or distinct marks or numbers. In fact, there is no case law specifically using the lack of earmark to explain the currency of coins. Rather, lack of earmark, in the sense of a distinguishing mark, was used to explain why Detinue was unavailable as action for the recovery of money. Specific identification was strictly required if only because an action in Detinue “affirms always property” in the plaintiff,34 so that, it in Detinue, the defendant had the option of returning the detained chattel rather than paying its value.35 However, on its part, identification required distinguishing marks that are not available for individual coins.

Indeed, money enclosed in a chest, bag or other receptacle, so as not to be used as current coin,36 was recoverable in Detinue.37 In such a case, the recoverable object was not a sum of money, but the container enclosing the money. Such a “box under seal”, rather than the sum of money, was sufficiently identifiable so as to be conceived as the specific chattel to be recovered in Detinue.38 Stated otherwise, Detinue was available “to recover the thing it self”; conversely, “in a detinue of money delivered, if it be out of a bag, the action lyeth not, because no certain property can then be known.”39

Similarly, it was held in Higgs v. Holiday (1600)40 that when a buyer pays the

price of goods to the seller’s servant, “[t]he property of the money was never41 in the 34 Bishop v. Viscountess Montague (1601) Cro. Eliz. 824, 78 E.R 1051. 35 See Fox, above note 9 at 550. Accordingly, a “bailee of a horse who killed it by overwork” could meet an action in detinue by returning its corpse. Cf. A.W. Simpson, “The Introduction of the Action on the Case for Conversion” (1959), 75 L.Q.R. 364, 368 dealing with the availability of trover and conversion in that case. 36 For this qualification, see Anon. (1619), 3 Leon 38, 74 E.R. 256, under which Detinue does not lie for money “sealed up in a bag” given to the bailee to buy goods for the bailor. 37 See e.g. Sir George Walgrace’s Case (1687) Noy 12, 74 E.R. 743. 38 Luffenham v. Abbot of Westminster (1313), Y.B. Hil. 6 Ed. II (43 SS) 65. See Fifoot, above note 14 at 27-28. 39 Isaack v. Clark (1615), 2 Bust 308, 308; 80 E.R. 1143, 1145. 40 Cro. Eliz. 746, 71 E.R. 978. 41 “Never” may be an overstatement; under a more refined analysis, the master had the property in the coins only to promptly lose it for inability to identify them. See below discussion at the end of the paragraph that immediately follows.

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master [namely, the seller], but of the servant;” this was rationalized as an application of the general rule under which “if a man delivers money to another, the property thereof is in the bailee, because it cannot be known.” Accordingly, the servant who declines to remit the proceeds to the master has not appropriated them, and is liable to him in account, but not Trover.42

Indeed, subsequently the House of Lords reasoned in Foley v. Hill (1848) that

money received by an agent from a buyer of goods sold to the buyer by the agent on behalf of the principal “remains property of the principal”;43 from this it would follow that any claim to the money by the agent depends on his “right to appropriate” it, “making himself a debtor to the” principal,44 rather than on automatic loss to the right to the money. However, even under this view, a claim to the specific monetary objects (whether coins or banknotes) can be raised by the principal/master45 only as long as they can be distinguished; if not individually, then at least by the ‘container’ or bank account into which they are segregated.46 In other words, money in the common law “could be followed … provided it could be earmarked or traced into assets acquired with it,”47 or more in general, “the thing produced ought to follow the nature of the thing out of which it is produced,48 [only] if it can be distinguished.”49

42 Higgs v. Holiday (1600) above note ???. 43 2 H.L.C. 28, 35; 9 E.R. 1002, 1005. 44 ??? Langdell, “A brief Survey of Equity Jurisdiction” (1889) 2 Harv. L. Rev. 241, 245. 45 For the treatment of a factor (of a principal) as a servant (of a master) so as to justify similar rules to issues discussed here, see e.g. ??? Holmes, “The History of Agency” in A.A.L.S. Select Essays in Anglo-American Legal History, vol. 3, 368 (first published in (1891), 4 Harv. L. Rev. 345) and 390 (first published in (1891), 5 Harv. L. Rev. 1) (???: ???, 1909) at 309. 46 Strictly speaking money in a bank account is a misnomer; rather, once deposited with a bank, depositor’s money becomes the property of the bank, and is replaced, in the depositor’s hands, with a debt claim against the bank. Foley v. Hill (1848) above note ???. Thus, the money is followed into the debt owed by the bank. In the sense of the quoted language which immediately follows, the debt then becomes an “earmarked” asset acquired with the money. 47 Sinclair v. Brougham [1914] AC 398, 420 (H.L.) 48 However, with the view of accommodating commercial expediency, more recently, some courts consciously abandoned strict identification in favour of “close and substantial connection”. Cf. Agricultural Credit Corp. v. Pettyjohn [1991] 3 W.W.R. 690, ??? (Sask. CA), dealing with tracing a one herd into the proceeds of a second herd bought with money realized from the sale of the first herd.

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In short, property follows possession “where the true owner hath no marks to

ascertain his property, as in money” other than when it is segregated;” 50 it is practically impossible to follow coined money into the hands of another, and it does not matter whether this other person is an innocent purchaser for value, a finder, or even a thief. Hence, since an individual coin lacks a distinguishing feature, it is not only the bona fide purchaser for value in possession of coined money who defeats the property right of a prior owner; consequently, no independent currency rule developed for coined money.

However, the monetary landscape changed with the introduction of paper money.

As was recognized by Lord Holt,51 each individual banknote bears a number or otherwise may have a distinctive mark. Indeed, in cases decided as of the 18th (if not late 17th) century52 with regard to the right to follow money, judges must have already envisaged banknotes. However, they were faced with the reality that usually people do not take notice of distinguishing features of individual banknotes; in the normal course of business they do not record numbers of banknotes but rather treat them as fungible. Such treatment by people is not sloppy; it is essential for the smooth operation of payment transactions and the flow of commerce. Practically then, most people would not be able to identify banknotes, given or taken, whether voluntarily or involuntarily, out of their possession. From this perspective, there is no difference in the treatment by people of coins and banknotes, so that for most cases the law regarding the right to follow money remained unchanged; after all, there is no difference between no earmark to an earmark that has not been noted.

However, legal doctrine had to take into account the possibility that in some cases people may take advantage of the innovation introduced by banknotes and record the identification numbers of banknotes held in their possession. Certainly, then, such banknotes may be identified in the hands of a third-party and hence, under contemporary legal doctrine, may have been followed and claimed by an owner who had lost or been dispossessed of them. It is at this point that a currency rule, as an exception to the right to follow, had to be formulated. More in general, the importance of the currency quality of money, heretofore taken for granted, came to be recognized as a feature supporting circulation and hence liquidity so as to facilitate a smooth flow of commerce. As such, if

49 Scott v. Surman (1743), Willes 400, 404; 125 E.R.1235, 1238, specifically in relation to the debt owed by the buyer for the price of the goods that being “distinguishable” belongs to the principal/master (original owner) and not the agent/servant (who sold the good on the owner’s behalf). 50 Hartop v. Hoare (1743), above note 28 at 50 (Atk.), 832 (E.R.). 51 In Anon. (1699), above note 10. 52 Including Isaack v. Clark (1615) above note 39; Hartop v. Hoare (1743) above note 28; Scott v. Surman (1743) above note 49; and Foley v. Hill (1848) above note ???.

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it were to equally apply to all forms of money, a new uniform rationale had to be formulated.

It is to that end that Lord Holt in Anon. (1699)53 and Lord Mansfield in Miller v. Race (1758)54 formulated a new comprehensive theory for currency, based on the inherent nature of money, and thus applicable to whatever constitutes money, either by law or societal consensus, as may be evidenced by the treatment given to it by merchants. Arguably, it was with the view of eliminating any possible distinction between the application of the currency features to coins and banknotes that Lord Mansfield went as far as to defy history and dismiss altogether the ‘earmark’ premise, heretofore responsible for bypassing the need to formulate a currency rule. Historical truth was thus sacrificed in order to secure a cohesive doctrinal basis for the future.

Arguably, then, according to Lord Mansfield’s formulation, the currency feature

is attributed to monetary objects in order to enable their use to best implement, as circulating media, the function of money. Once banknotes had come to be used as money they became automatically governed by this rule.55 As it was broadly stated, the currency rule turned out to be flexible enough to be able to subsequently cover also ‘bank money’, in the form of credit to a bank account, as a means of payment. Thus, while not interfering with the following of money into a segregated bank account56 as well as to its tracing into an account where it is mixed with other funds,57 the currency rule effectively afforded protection to a bona fide payee for value out of such accounts.58

Rogers is however sceptical of this understanding of Lord Mansfield’s decision

and hence of the conventional rationale to the currency rule. He starts by acknowledging that:

“The usual explanation to the [currency] rule is that it would impede the utility of money if a good faith taker were subject to remote claims, for then people would

53 Above note 10. 54 Above note ???. 55 Miller v. Race (1758), above note ???. 56 For this right see .e.g. Taylor v. Plumer (1815) 3 M. & S. 562, 575; 105 E.R. 721, 726. 57 For this right see e.g. Re Hallett’s Estate (1880), 13 Ch. D 696 (CA). 58 Cf. General Motors Acceptance Corp. v. Bank of Nova Scotia (1986), 55 OR (2d) 438 (CA) where albeit without specifically mentioning the currency rule, the Court effectively applied it in disallowing tracing into amounts withdrawn in the ordinary course of business from a bank account.

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be less willing to accept money as payment without making inquiries about its provenance.”59

However, he goes on to say that “the argument seems rather implausible. One suspects that people’s inclination to accept money has a great deal more to do with the upside potential than the downside risks.” They “routinely accept paper money without any investigation“ even though banknotes may be either stolen or counterfeit.60

Accordingly, Rogers endeavours to interpret Lord Mansfield’s dismissal of the

“money has no ear-mark” rationale as relating to money in the sense of an abstract unit of account rather than consisting of monetary objects. However, in my view, this is unconvincing not to mention anachronistic. It is unconvincing because it is not the abstract unit of account but rather ‘bank money’, in the form of credit to a bank account, which moves over the non-cash payment systems. It is also anachronistic; true, as just pointed out,61 the currency feature applies to ‘bank money’, so as to exempt a bona fide purchaser62 for value from a tracing claim to that money, and certainly, there is no “earmark” to any unit of “bank money”. However, ‘bank money’ was not widespread in Lord Mansfield’s era. Regardless, the plain meaning of Lord Mansfield’s text suggests a reference to monetary objects, namely, coins and banknotes, and not to “abstract units of accounts” transferable in modern “electronic funds transfer systems”.63

On his part, Rogers purports to explain the currency of monetary objects on the

intention of parties involved, whether the one who delivers money for whatever purpose, the recipient of money, or one who is to obtain it out of commingled funds. Due to the fungibility of money, any such a person does not care about the individuality of any banknote. Indeed, this reasoning does not extend to apply the currency rule to a bailor of money who, in a given case, may be concerned with the solvency of the bailee. As well it does not apply to one who identifies lost or stolen money in the hands of a third party other than a bona fide purchaser for value.64 Nor does it cover even “bank money” that

59 JS Rogers, “Negotiability, Property, and Identity” (1990-91), 12 Cardozo L. Rev. 471, 501. [hereafter: Rogers, “Negotiability”]. The ensuing discussion purports to present Rogers view as in this article. See also earlier articles by him, “Negotiability as a System of Title Recognition” (1987), 48 Ohio L. Rev. 197; and “The Myth of Negotiability”, (1989-90) 31 BC L. Rev. 265. 60 Rogers, “Negotiability”, ibid. at 501. 61 [c/r a few fn above] 62 In this context, ‘purchaser’ is used loosely to include ‘receiver’ or ‘payee’ as well. 63 Rogers, “Negotiability”, above note 59 at 504. 64 Cf. Taylor v. Plumer above note ???, dealing with securities and bullion as proceeds of money paid to honour a draft.

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can be traced in equity other than in the hands of a bona fide purchaser for value.65. And certainly it does not cover the case of a person who, other than in payment for value received, delivered banknotes whose numbers he deliberately recorded. In all such cases an owner may succeed to recover, other than against a bona fide purchaser of value, bailed, stolen, misappropriated or lost money even if not segregated, by simply identifying individual banknotes, or at least, tracing the money.

I understand Rogers’ rationale to support this conclusion for all such cases;

however, his rationale does not seem to capture the reason for the bona fide purchaser for value, and no one else, to nevertheless prevail over the owner who took all these precautions. For example, his reasoning does not explain why a bona fide purchaser for value, and only a bona fide purchaser for value, will prevail over a bailor betrayed by the bailee, over banknotes specifically identified by the bailor to be segregated and safely kept by the bailee, who nevertheless paid with them, and which were received by the bona fide purchaser for value.

True, in suing someone in possession of banknotes, a former possessor is likely to

be satisfied upon receiving the amount claimed rather than necessarily the very banknotes that form the subject matter of the litigation. Certainly, against a thief or finder, the former possessor needs only prove the theft or finding (and the amount) of the money; he will win even if he proves this otherwise than by identifying the specific banknotes in the defendant’s possession. However, identification of the banknotes is likely to be an easy way to prove his claim even against such a defendant. Moreover, against a third party who received the banknotes from the thief or finder, positive identification of the banknotes is required; once it happens, the only third party to oust the former possessor is he bona fide purchaser for value. Moreover, positive identification is necessary in order to succeed to claim the entire amount, by setting a proprietary right, against an insolvent defendant, including a thief or finder.66 Hence, identification of banknotes, rare as it is, has practical implications not ignored by law.

In observing that risks of stolen or counterfeit monetary objects are usually ignored by people, 67 Rogers appears to be only partly right. His observation is correct only for an environment in which there is confidence in the genuineness of circulating currency,68 and only for relatively small cash payments.69 Otherwise, Rogers’ observation

65 c/r 66 Otherwise, the former possessor is left with a claim for a dividend in the insolvency proceedings. 67 c/r 68 Conversely, he is probably right even where there is abundance of lawlessness generating circulation of a great number of stolen banknotes, precisely because of the currency rule.

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is an overstatement. As explained below, human behaviour is more complex and its implications do not deny the rationale of the currency feature of money as a lubricant for the smooth flow of commerce.

Thus, the risk of counterfeit banknotes is reduced by enhanced security features in

banknotes and credible law enforcement; in any given situation, the greater is the risk of circulating counterfeit banknotes, the lower is the confidence in the currency system, and the greater precautions are taken by receivers of banknotes.70 In fact, when a word comes out as to the circulation of counterfeit banknotes of a specific denomination or other common description, it is not uncommon to see signs posted by retailers indicating their refusal to receive banknotes of that denomination or description. As well, in large cash transactions it is not uncommon for payees to take precautions designed to ensure that banknotes they take are genuine.71 Finally, where the wrongdoer is not available to cover the loss, protection for the taker of a counterfeit banknote is politically unfeasible; this is so since other than if an insurance scheme is devised, protection can be implemented only by allocating the loss to the purported currency issuer. This is likely to happen only where the currency issuer deems it necessary to cover such losses in order to protect the integrity of its currency system.72

Certainly, a receiver of money, including “bank money”, can endeavour to verify

the provenance of funds paid by his payer. However, such attempts may be onerous and unsuccessful; and for sure, they will slow down the circulation of money. As well, no precautions can be taken against receipt of stolen banknotes other than the verification of each number (or other identification mark it bears) against a data base. Technologically such verification is more feasible nowadays than in those of Lord Mansfield; and while per Rogers’ observations, payees of small amounts may bypass this verification and take the risk, this is not necessarily so for takers of large amounts. Overall then, in the absence of a currency rule, commercial transactions would have slowed down.

At its inception, as pronounced by Lord Mansfield, the currency feature

concerned monetary objects. In the final analysis, ‘currency’ is designed to secure circulation of money so as to accord the bona fide purchaser for value protection exactly in those cases where an earlier owner can identify monetary objects or trace ‘bank money’ received by the purchaser. Indeed, intention may be manifested to exclude the currency rule, e.g. when banknotes are delivered in a sealed bag for safekeeping; and yet, 69 What is a small or large amount may be in the eyes of the beholder, as well as changes for different eras; no attempt will be made to draw a fixed distinction. 70 An extreme situation (certainly in a failing country) is where people accept only banknotes certified by reputed moneychangers to be genuine. 71 Such precautions may include the use of sophisticated equipment. 72 Cf. e.g. Banco de Portugal v. Waterlow and Sons, Ltd [1932] A.C. 452 (H.L.),

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even in such a case, the currency rule will apply to protect the bona fide purchaser for value of such banknotes. Intention and practice of parties in usually overlooking number and identification marks of individual banknotes is relevant to explain the paucity of cases involving the currency rule and yet it does not explain the rule itself. Moreover, unlike banknotes and coins, ‘bank money’ can easily be followed and traced; hence the increased importance of the currency rule even as a practical matter.

A remaining issue is the extension of the currency rule, in the form of the first element of ‘material negotiability’ to bills of exchange, cheques and promissory notes that do not serve strictly as ‘money’. The question became obscured by the policy to treat all such instruments uniformly as ‘negotiable instruments’; in part, this policy was premised on the view that negotiable instruments actually circulate so as to “form part of the currency of the country”.73 Against this background, the extension of ‘negotiability’, in the sense of freedom for adverse claims, to instruments other than banknotes, had at least one major ‘collateral benefit’ in the form of enhancing the discounting and circulation of bills of exchange payable to order74 on which the expansion of banking became partly dependent.

Thus for example, suppose owner-holder of a bill of exchange payable to order

endorsed it and delivered it to an intermediary either by way of pledge for a loan or for safekeeping. The intermediary however betrayed the owner (the previous holder); he discounted the bill of exchange with a bank and misappropriated the proceeds. In this case the effect of negotiability was to protect the discounting bank, as long as it was a good faith purchaser for value, from the adverse claim of the defrauded owner.75

Certainly, in facilitating smooth circulation, this result enhanced the benefit of the discounting practice.

However, English law had been capable of reaching this result even without the

doctrine of negotiability. Thus, English law protected the rights of a bona fide buyer for value, of goods (i) as against the owner, where the buyer bought the goods from the owner’s mercantile agent, who was in possession of the goods, and who sold the goods in breach of the owner’s authority,76 (ii) as against an earlier buyer, where the buyer bought the goods from a seller who had agreed to sell the goods to the earlier buyer but remained in the possession of the goods,77 and (iii) as against the seller where the buyer bought the goods from an earlier buyer who had taken possession but had not acquired

73 Cf. the view that see Foster v. Mackinnon (1869), 20 L.T.R 887, at 889. 74 See e.g. Holden, above note ??? at 294-298 75 See e.g. London Joint Stock Bank v. Simmons [1892] AC 201 (AC). 76 Factors Act ??? Section 2(1). Case? 77 Sale of Goods Act ??? Section 25(1) case?

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title yet.78 Protection to the bona fide purchaser for value of an endorsed bill of exchange payable to order could have been provided on a similar basis without invoking ‘negotiability’ as a special rule applicable to bills, cheques, and notes.

Indeed, in the absence of ‘negotiability’, protection from adverse claims would

not have been complete. The common law treatment of the purchaser of a certificate relating to a registered share, who took it, for value and in good faith, bearing a blank endorsement by the registered shareholder, is a case to the point. Under the common law, such a share certificate is not negotiable; however, under Colonial Bank v. Cady (1890),79 the bona fide purchaser for value of a registered share certificate endorsed in blank who derived his title from the original registered owner, would have been protected from adverse claims. At the same time, when he derived his title from a thief, the purchaser would not have been protected against the dispossessed earlier holder (including the original registered owner). For sure, other than under negotiability, the same limitation would have applied to the bona fide purchaser for value of an endorsed in blank bill of exchange payable to order.

Indeed, this limitation is not inevitable; rather, it is based on the law as it is rather

than as it could be. In fact, towards a bona fide purchaser for value, it would not have been impossible for general law to extinguish the ownership of a dispossessed holder, whether of an endorsed in blank share certificate or an instrument payable to bearer or endorsed in blank, on the basis of estoppel.80 Such a rule would have conferred on the bona fide purchaser for value the freedom from adverse claims as if under the doctrine of negotiability. However, as noted, common law did not go that far; yet it provided protection to the share purchaser under general rules of law. Certainly, it could have done the same to the taker of the endorsed in blank bill of exchange payable to order even in the absence of the doctrine of negotiability.

In any event, while extending the benefit of negotiability to bills, notes and

cheques, that is, all instruments falling under what had been conceived as ‘law merchant’ English law did not go as far so as to allow the free circulation of instruments payable to order over a forged endorsement.81 On this point, Continental law, went the other way;

78 Sale of Goods Act, ibid. Section 25(2). Case? 79 15 App. Cas. 267 (H.L.), dealing with acquisition from executors of a deceased shareholder, and supporting the protection of a purchaser of an indorsed in blank registered share certificate while confirming its non-negotiability. 80 Cf. Sale of Goods Act, above note ???, Section 21(1) (buyer of gets good title to goods sold by non-owner where “he owner of the goods is by his conduct [is] precluded from denying the seller's authority to sell”. Arguably, one in possession of an instrument endorsed in blank may so be precluded. 81 For an overview with regard to cheques see B. Geva, Bank Collections and Payment Transactions: Comparative study of legal aspects (Oxford: Oxford University Press,

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while originally being the same as English law on this point, already as of the course of the 18th century it moved in the opposite direction, allowing the forged endorsement to pass title to a an instrument payable to order free of adverse claims of the dispossessed holder. 82 Accordingly, with regard to a contest between a dispossessed holder of an instrument payable to order, and a subsequent bona fide purchaser for value of the instrument, claiming through a forged endorsement, English law declined to follow Miller v. Race (1758).83 Rather, explicitly preferring the property right of the dispossessed owner, and highlighting the policy of loss minimization achieved by requiring an endorsee to verify the good title of his endorser, the majority in Mead v. Young (1790) decided in favour of the dispossessed owner.84 This position is codified both in the English BEA85 and American Article 3 of the Uniform Commercial Code (“UCC”).86 Thus, in principle,87 in Anglo American law, a negotiable instrument payable to order passes from an endorser to endorsee free of adverse claims only insofar as it bears a genuine endorsement.88 3. Freedom from contract defences

Typically, the maker's obligation on a note is on debt he owes the payee. On his

part, not necessarily knowing much on the drawer's debt to payee (not to speak of each endorser's debt to his respective endorser), the acceptor is more likely to be liable on a bill by reference to his own obligation to the drawer. Is the obligation of a maker of a note and that of the acceptor on a bill enforceable free of defences available to the maker

2001) at 422-434 (following of which there is a detailed discussion of the allocation of forged endorsement losses in major legal systems). 82 The point is now codified in Article 16 of Convention Providing a Uniform Law for Bills of Exchange and Promissory Notes, 7 June 1930, 143 L.N.T.S. 257, Annex I, on which legislation throughout the world is modeled in civil law countries including those in Continental Europe. For an excellent historical review see F. Kessler, “Forged Indorsements” (1938), 47 Yale LJ 863, 863-71. 83 Above note 13. 84 4 T.R. 28, 100 E.R. 876. 85 BEA above note ???, Section 24. 86 Section 3- 403 of the American Uniform Commercial Code (1990, as amended 2002). 87 For cheques, exceptions are discussed in Geva, Bank Collections above note ??? at 465-487 (for jurisdictions that adopted the English Bills of Exchange Act, with or without variations) and 501-514 (for Article 3 of the Uniform Commercial Code in the US). 88 See note ??? above, and text around it. London Joint Stock Bank v. Simmons

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against the payee and to the acceptor against the drawer? Indeed, the holder’s freedom from contract defences, being the second aspect of material negotiability, enhances circulation. However, does the holder’s defence-free position exist, and can it be explained either by the language and form of a negotiable instrument, or by the effect of the good faith acquisition for value of the instrument? The holder’s power to enforce an instrument free from the obligor’s defences became a practical issue with the increase of the use of negotiable instruments for payment for goods. Indeed, compared to a buyer of goods, an issuer of a banknote, but also a borrower of money, is less likely to have and hence raise defences to his liability. Not surprisingly then, the holder’s freedom from contract defences was taken advantage of in the course of the industrial revolution, with the rise of retail credit sales, during the 19th century.89 However, as will be demonstrated, the holder’s defence-free position had been confirmed already in the course of the 18th century.

The defence-free position of the payee towards the drawee with whom he has not dealt appears to be traced to Baker v. Lambert and Grelle v. Lambert (1510-13).90 In that case, according to Beutel, "a drawee [who was sued] ... by a payee ... [did] not offer as a defense that the drawer ... [had been] indebted to him ..."91 However, this was an exchange transaction, so that the drawee was in fact an agent of the drawer and the payee was an agent of the remitter; payee’s action must have been that of the remitter-lender against the drawer-borrower.92 In such an action, drawee’s defences against his principal, the drawer, are certainly irrelevant. Hence, the case cannot be cited for the broader proposition as to the independent right of the payee against the drawee free of the latter’s defences against the drawer.93

In any event, in Baker v. Lambert and Grelle v. Lambert (1510-13), the drawee

did not even accept the bill. At the same time, later, towards the end of the first quarter of the 17th century, Malynes confirmed the view that a drawee who accepted a bill could not

89 In this context, for example, for the 19th century development of the promissory note becoming a credit instrument issued by a retail buyer, see G. Gilmore, “Formalism and the Law of Negotiable Instruments” (1979/80), 13 Creighton L Rev. 442, 451-453. 90 Reprinted in (1929) 46 Selden Soc. 2, Select Cases Concerning the Law Merchant 138. 91 FK Beutel, “The Development of Negotiable Instruments in Early English Law” (1938) 51 Harv. L. Rev. 813 at 832, n. 94. The facts as to the drawer's indebtedness to the drawee "appear in the same case". Ibid. 92 93 Notwithstanding my own conclusion to the contrary in B. Geva, Financing Consumer Sales and Consumer Defences in Canada and the United States (Toronto: Carswell, 1984) (here after: Geva, Financing) at 84.

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raise against the payee defences available to him, the drawee, against the drawer. 94 A similar view was expressed by Marius in the middle of the 17th century.95 Both, however, addressed their remarks only to the acceptor’s defence based on the insolvency of the drawer.

The payee is not a purchaser of the negotiable instrument. His defence-free

position can be rationalized on the autonomy, that is abstract or absolute nature, of the obligation on a negotiable instrument. Under this explanation, the absolute nature of the obligation is a function of the form or language of the instrument,96 namely, the unconditional promise of the maker of the promissory note and where applicable, the unqualified acceptance of a bill of exchange.97

To that end, an analogy can be drawn between the availability of the obligor's

defences in an action on a negotiable instrument and their availability in an action on a document under seal ("specialty contract"). A negotiable instrument, "quite like … a specialty … stands apart, complete in itself”. 98 Its effect on the transaction under which it is given, 99 is akin to the effect of an undertaking contained in a specialty contract ("obligation") on the contract evidenced by it. As early as 1422 it was indeed determined

94 Malynes, above note ??? at 274. See Holden, above note ??? at 41-42. See also W. Holdsworth, A History of English Law vol. VIII, 2nd ed. (London: Methuen, Sweet & Maxwell, 1937, rep. 1966) at 157. 95 Marius above note ??? at 20. See Holden, above note ??? at 47. 96 Section; case 97 Section; case 98 R.W. Aigler, “Conditions on Bills and Notes” (1927-28), 26 Mich. L. Rev. 471, 480 n. 35. 99 Where a bill or note is given by way of payment, the payment may be absolute or conditional. There is however a rebuttable presumption in favour of “conditional payment". See e.g. AG Guest, Chalmers and Guest on Bills of Exchange, Cheques and Promissory Notes 16th ed. (London: Sweet &Maxwell, 2005) at 493. See also A. Barak, "The Uniform Commercial Code - Commercial Paper: An Outsider's View Part II" (1968), 3 Israel L. Rev. 184, at 214; and F. Kessler, E.H. Levi and E.E. Ferguson, "Some Aspects of Payment by Negotiable Instrument: A comparative Study" (1935-36), 45 Yale L.J. 1373, 1374. The doctrine of conditional payment (except for when the instrument is signed by a bank) is presently provided for by Section 3-310(b) of the American Uniform Commercial Code (UCC Article 3, 1990, as amended 2002).

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that "if I am your debtor. . . by a simple contract and I make an obligation to you for the same [amount] on the same contract . . . I am discharged of the contract by obligation".100

It was settled under Medieval common law that "in Debt on a contract the

plaintiff shows in his count for what cause the defendant has become his debtor: otherwise in debt on an obligation [i.e. specialty], for the obligation is a contract in itself".101 Being of "high nature" the undertaking under a specialty contract was divorced from the consideration thereto and could not be varied or contradicted by any extrinsic evidence. "The defendant was bound by the deed, the whole deed and nothing but the deed."102 Accordingly, failure of consideration under the basic transaction did not constitute at common law a valid defence to an action on the deed.103

The inability of the obligor to meet an action on it by defences arising from the

underlying transactions makes the obligation autonomous or abstract. However, the origin of this autonomy or abstraction is not easily traceable.

As a matter of Roman law terminology, a written obligation is autonomous or

abstract when it is under a literal, unilateral, stricti juris, and formal contract.104 Outside Roman law, already the middle of the second century CE, Gaius was familiar with “an obligation by writing”, or even more specifically, “a literal obligation”.105 Such an obligation “appears to arise through the documents called in Greek ‘chirographs’ and ‘syngraphs’”;106 However, Roman law declined to adopt such legal instruments, and their

100 Salman v. Barkyng (1422), Y.B. 1 Hen. VI (S.S. vol. 50), 114 at 115 per Babington J. Note the medieval terminology: "contract" is not "promise" but the benefit conferred on the defendant under the transaction. "Obligation" is the specialty contract. See Fifoot, above note 14 at 225. 101 Anon (1385), Bellewe Ill, 72 E.R. 47 (the English translation, according to Fifoot, Ibid. 102 Fifoot, above note 14, at 23l. 103 J. B. Ames, "Specialty Contracts and Equitable Defenses," in Lectures on Legal History (Cambridge: Harvard University Press, 1913) at 104, 108. 104 105 F. De Zulueta, The Institutes of Gaius, Part I: Text with Critical Notes and Translation (Oxford: Clarendon Press, 1946) at 195. 106 F. De Zulueta, The Institutes of Gaius, Part II: Commentary (Oxford: Clarendon Press, 1953) at 166 explains that while the chirograph was a letter written by the debtor addressed to the creditor, the syngraph was a witnessed document sealed by both parties and deposited with an official. While the chirograph was signed by only by the debtor the syngraph was signed by both parties. See A. Berger, Encyclopedic Dictionary of Roman

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precise legal underpinning may not be adequately clear.107 On its part, the Jewish Talmud requires a documentary note of indebtedness to be a shetar; it thus has to comply with formality requirements,108 even if only as to adequate witnessing.109 However, the Talmud allows for the issue of a legal document whose binding effect and terms may be subject to conditions orally stated by the issuer at the time of the issue.110 As such, under the Talmud, the documentary note is not a stricti juris contract, and is thus incapable to be the source of the English deed.

Rather, the autonomy of the English deed resembles the abstract nature of the

Roman law stipulatio. Being self-contained, namely, confined to the contours of the

Law (Philadelphia: American Philosophical Society, 1953) at 338 (v. Chirographum) and 727 (v. Syngraphe). De Zulueta further asserts that according to the modern view, “documents in either form could be abstract contracts, though purporting to be evidence of a debt from some (fictitious) causa, the commonest fiction being that of a loan …” Ibid. For the latter point, cf. JW Jones, The Law and Legal Theory of the Greeks: An Introduction (Oxford: Clarendon Press, 1956) at 220-22. 107 Cf. e.g. Berger, ibid. at 727, according to whom “It is doubtful whether a syngraphe was valid if the obligation assumed therein by a party was not based on a real transaction”. 108 “Every shetar, as a formal document, requires the signatures of witnesses”. Otherwise, an informal unwitnessed document is a mere piece of evidence for an oral contract. See AM Fuss, “Shetar”, in M. Elon, ed., The Principles of Jewish Law (Jerusalem: Keter, 1975) (Reprinted from Encyclopedia Judaica, 1st ed.), Columns 183-90 at 184. But according to the Rambam, for a documentary note of indebtedness on a loan (shetar hov) manually written by the debtor there are no formal requirements other than as witnessing. See Rambam, Mishpatim: Hilchot Malvé ve-Lové Section 11, Rule 2, as well as Section 27, Rule 1. 109 The Talmud records a disputation as to whether a documentary note of indebtedness (Shtar Hov) has to meet witnessing requirements. See Talmud, Gitin at 86B. Maimonides upholds witnessing requirements with respect to either the signature of the debtor or the delivery by him of the document to the creditor. See Rambam, ibid. Section 11, Rules 2 and 3. According to the Magid Mishna commentary to the Rambam, ibid., this reflects the majority view among the post-Talmud Rabbis. Delivery witnesses as a replacement for signature witnesses are discussed e.g. by Rashi, Talmud, Bava Batra at 176 D”H “Vegoveh”. Witnessing requirements are also discussed in Choshen Mishpat Sections 40 and 51 in both Tur and Shulchan Aruch. 110 See e.g. Talmud, Gitin, at 84B (a bill of divorce subject to external conditions) and Ketuvot at 19B (validity of testimony as to a condition). Cf. Shulchan Aruch, Chosen Mishpat, Section73, Rule 3 (including Shach 9), in conjunction with Rule 1, where lender lost upon failure to prove an alleged condition.

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formula and not to any outside event, the stipulatio is a formal, unilateral, and stricti juris contract. However it is a verbal contract, solemnly concluded in a face-to-face exchange of a question and an answer between two persons.111 It is not a literal, namely, written contract. Certainly however, even if the origins of the English specialty can be traced to formal notarized documents appearing around the time of Justinian, 112 the underlying legal theory is that of a Roman unilateral stricti juris formal contract; albeit, contrary to the verbal stipuatio, the English specialty or deed is a literal contract.

Along similar lines Ames was of the view that “[i]n Scotland and Europe

generally, a bill or note is recognized to be a literarum obligatio…”113 As a general statement this may be an overgeneralization; in fact this characterization is correct for Germany, and not for France. However, the Continental approach does not prove to be helpful. In both Germany and France, pragmatic considerations prevailed,114 so that the issue of a bill of note does not novate the obligation for which the instrument was given. As a result, defences arising from the underlying transaction are not forfeited and remain available to the obligor against the payee, and in fact against any transferee other than in good faith.115

Consistently with this Continental position for bills and notes, the abstract nature

on the obligation on a deed under the Common Law was seriously compromised in England by Equity where defences founded on the conduct of the obligee on a specialty could successfully be raised. Thus, "whenever it was plainly unjust for [the obligee] to insist upon his strict legal right" the Chancellor would "furnish the obligor with a defense by enjoining the action".116 Equitable jurisdiction encompassed the defence of failure of consideration under the underlying contract.117

111 112 For formal notarized documents under Justinian (and shortly before him), see AP Usher, The Early History of Deposit Banking in Mediterranean Europe vol. I (Cambridge, Mass: Harvard University Press, 1943) at 41-44. 113 Ames, above note 103 at 115 n. 2. 114 Albeit compared to France, in Germany, where the bill or note is truly a literarum obligatio, both the reasoning leading to that result – and the procedural mechanisms to achieve it -- are much more torturous. See cites in the ensuing note. 115 See e.g. L. Dabin, Fondements du droit cambiare Allemand (Liège, Faculté de droit de Liège, 1959) at 204-213, 261-266, 334-343 and 422-427 (for Germany); C. Gavalda & J. Stoufflet, Instruments de paiement et de crédit, 7ème éd. rédigée par J. Stoufflet, (Paris: LexisNexis, 2009) at 59-61, and 77 (for France) ; and G. Ripert & R. Roblot, Traité de droit commercial 13ième éd. (Paris: Librairie Gènèrale de droit et de jurisprudence: 1992) at 144, 156-160, and 216-220 (for France with a comparison to Germany).

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Though in itself not a specialty, 118 a negotiable instrument has been characterized

as "the modern mercantile specialty". 119 Chafee accordingly suggested that equities affecting the right to sue upon the instrument ("equities as to liability") are parallel to grounds upon which an obligor on a specialty "would before modern statutes120 have had to go into chancery to maintain his defense". 121 While the availability of failure of consideration against an action on a specialty contract is supported by case law dealing with total failure of consideration alone, 122 once the veil separating the deed and the basic transaction has been pierced, no logical line can be drawn between different types of defences available on the underlying contract.

In the final analysis, the analogy to a specialty or a deed does not advance the

search for a theory underlying the defence-free position of a holder of a negotiable instrument. First, English law classifies the obligation on a negotiable instrument as one on a ‘simple contract’ rather than a deed. Second, the defence-free position of a claimant on a specialty at common law was anyway reversed by equity. Third, even the German characterization of the negotiable instrument as a literarum obligatio has not operated to insulate the holder from defences arising from the underlying transactions. Not surprisingly, even the characterization of the negotiable instrument under Anglo-American law as a “modern mercantile specialty” does not render the obligation thereon absolute and defence-free. As previously indicated, this characterization may explain why in suing on the instrument the holder is dispensed with the need to prove the liability of a party beyond producing the latter’s signed instrument; and yet, this characterization does not preclude the signer from successfully meeting the action on the instrument by proving defences arising from the underlying transaction.123

116 Ames, above note 113 at 106. 117 Ibid., at 108-9. Other defences were frauds', illegality, payment, accord and satisfaction, discharge of surety, accommodation, duress, agreement not to sue and acquiescence. 118 Cf Rann v. Hughes (1778), 7 T.R. 350 at note (a), 101 E.R. 1014: at note (a). 119 Ames, above note ???, at 115. 120 The Common Law Procedure Act, 1854, c. 125, s. 83. 121 Z. Chaffee, “Rights in Overdue Paper” (1917-18), 31 Harv. L. Rev. 1104, at 1111. 122 Tourville v. Naish (1734),3 P. Wms. 307, 24 E.R. 1077, and a "case of the time of Henry VI" whose facts are outlined by Ames, above note ??? at 108. 123

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More recently, it has been said that a bill of exchange124 "is itself a contract separate from the [underlying] contract of sale", operating "as a contract in its own right".125 This, however, should not necessarily result in the insulation of a holder of the bill from the defences arising from the underlying sale. Thus, in line with Chafee’s analysis, it was said that "[t]he laws distinguishing negotiable instruments from nonnegotiable instruments are not based upon any inherent distinctions between the obligations assumed in the one class or the other of such contracts".126 According to this view, the unconditionality of the engagement on a negotiable instrument goes to form only and is not a matter of substance. The right to meet an action on the instrument with defences based on the underlying transaction is thus not to be barred by the unconditional language of the engagement. "The content of a promise [or order] is one thing, the development and recognition of a defense is quite another".127

The view that prevailed in English law is that the defence-free position of a holder

is not premised on the unconditional language of the engagement of the party liable; rather it is based on the good faith purchase for value of the instrument by the holder. On this basis, protection is available only against defences of a party with whom the holder has not dealt, as for example, when the holder is an endorsee suing a maker of a promissory note. In fact, this is in line with the prevailing view in the Continent.128 Ames links the holder’s freedom’s from defences arising from the underlying transaction to the abstract nature of the obligation on the instrument which materializes only upon its negotiation in good faith and for value.129 While this bridges between the unconditional language and the taking by negotiation, certainly, it is the latter which confers a defence-free position on a remote party and not on an immediate one; had the unconditional language been the determinative factor there would have been no reason to distinguish between such parties and confer the defence-free position only on a remote one.

124 Certainly, there is no reason to suppose that the ensuing statement is limited to bills; rather, it equally applies to notes. 125 Nova (Jersey) Knit Ltd. v. Kammgarn Spinnerei GmbH, [1977] 2 All E.R. 463 (H.L.), at 479-80 per Lord Russell of Killowen. See also Anglo-Italian Bank v. Wells (1878), 38 L.T. 197 (C.A.), at 199. The "separate contract" theory led in these cases to a result discussed in text at notes ???-??? below. 126 Pitman v. Walker, (1922), 187 Cal. 667, at 672 (S.C.), cited with approval by Aigler, above note 98 at 479 n.33. 127 Aigler, Ibid. at 480. 128 See cites in note 115 above. 129 Ames, above note 103 at 115, text & note 2.

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According to Holden,130 the first judicial pronouncement explicitly standing for the ability of a bona fide holder for value of a bill of exchange to acquire a better title than that of his transferor was Hussey v. Jacob (1696).131 The case involved a bill of exchange given to the payee in settlement of a gaming debt owed to him by the drawer. The bill was thus tainted with illegality.132 On this basis, the payee's action against the acceptor was dismissed. It was nonetheless reported that Lord Holt expressed his opinion in that case that if a bill drawn by the losing gambler133 “was given to the winner or order, and the winner endorsed it to a stranger for a just debt, and the person upon whom the bill was drawn, accepts it in the hands of the stranger, the acceptor would be liable”.134

Lord Holt's statement in Hussey v. Jacob was an obiter dictum. But “[t]welve

months later [the] principle was applied in the Court of Chancery”.135 In Anon. (1697)136

an endorsee for value of a bill of exchange sued its drawer. The drawer brought a bill to be relieved in equity against a judgment given against him by a court of law. The drawer's argument was that “there was really no value received at the giving of this bill, and [the endorsee] would have no prejudice [and] might still resort to [his endorser] upon his original debt”.137 The drawer’s defence of absence of consideration was rejected unequivocally. The endorsee was “an honest creditor. . . coming by this bill fairly for the satisfaction of a just debt”.138 The Chancellor held that relieving the drawer “would tend to destroy trade which is carried on [everywhere] by bills of exchange, and. . . lessen an honest creditor's security".139 The ultimate decision was thus against the drawer.

130 Holden, above note 11 at 63. 131 1 Comyns 4, 92 E.R. 929. 132 Under 16 Car 2, c. 7, or the Gaming Act, 1664 (See Holden, above note ??? at 63). 133 While Lord Holt speaks of “a note”, the instrument involved in the case was a bill of exchange. Lord Holt must have used the term “note” rather loosely. 134 Above note 131 at 6 (Comyns), 930 (E.R.). 135 Holden, above note 11 at 64.

136 1 Comyns. 43, 92 E.R. 950. 137 Ibid. 138 Ibid . 139 Ibid .

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The insulation of a bona fide purchaser from a prior party’s contract defences may also be supported by Haly v. Lane (1741).140 It was held in that case that where an endorsee gave money for a void instrument, “it is a good note as to him, unless there should be some fraud or equity against him appearing in the case”.141 However, in this case the endorsee sued his endorser. It is thus uncertain whether the statement was intended to apply to the endorsee’s position vis-à-vis a prior party or merely his power to enforce the instrument as against his immediate endorser.

In Peacock v. Rhodes (1781),142 a good faith purchaser for value of a bill of exchange endorsed in blank, who derived his title from a thief, sued the drawer. Treating the instrument as a bill payable to bearer,143 in the footsteps of Miller v. Race (1758),144 Lord Mansfield held in plaintiff’s favour. The doctrine of negotiability was thus applied in that case to cut off prior claims of ownership. Nonetheless, according to Britton, the rule established thereby “also cut off defenses of prior parties”.145 Presumably he stated this conclusion from on the basis of Lord Mansfield’s statement in Peacock v. Rhodes (1781) according to which unlike an assignee who “must take the thing assigned, subject to all the equity to which the original party was subject”, “a holder, coming fairly by a bill or note, has nothing to do with the transaction between the original parties”.146In the view of Lord Mansfield, this was “within the principle” of Miller v. Race; in his view, if the rule under which the assignee of a debt is subject to defences arising between the original parties “applied to bills and promissory notes it would stop their currency.”147

The effect of the doctrine of negotiability to cut off defences of prior parties also

surfaced in Trueman v. Hurst (1785),148 Morris v. Lee (1786),149 and Lickbarrow v.

140 2 Atk. 181, 26 E.R. 513.

141 Ibid. 142 2 Doug. 633, 99 E.R. 402. 143 A position adopted by modern law, as per Section 8 of the Bills of Exchange Act, above note ???, providing that “A bill is payable to bearer which is expressed to be so payable, or on which the only or last indorsement is an indorsement in blank.” 144 Above note 13. 145 W. E. Britton, Handbook of the Law of Bills and Notes, Second edition (St. Paul, Minn:1961) at 245 & n. 7. Emphasis added. 146 Above note ??? at 635 (Doug.), 403 (E.R.) 147 Ibid. 148 1 T.R. 40, 99 E.R. 960.

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Mason (1787).150 In Trueman v. Hurst (1785) it was argued that “[i]n an action on a promissory note between the original parties, the consideration may be inquired into: but when it passes into the hands of third persons, it cannot".151 In Morris v. Lee (1786) the Court held that, “however improperly [a note] might have been obtained, a third person who took it fairly, and gave consideration for it, was entitled to recover”.152 In Lickbarrow v. Mason (1787) the Court observed with respect to a bill of exchange that “as between the drawer and the payee the consideration may be gone into, yet it cannot between the drawer and an indorsee. . .”153

The freedom of a subsequent. bona fide holder for value from prior parties'

defences comes out quite clearly in Brown v. Davies (1789).154 This was an action by an endorsee on a promissory note. Speaking of a precedent155 holding that “the maker, was entitled to set up [against the endorsee] the same defence that he might have done against the original payee”,156 Buller J. added “[t]hat a fair indorsee can never be injured by this rule; for if the transaction be a fair one, he will still be entitled to recover”.157 It was thus

149 B.R.H. 26 Geo. 3. 1 Comyns. 43 n. (1). 92 E.R. 950 n. (1). J. Bayley, A Short Treatise on the Law of Bills of Exchange, Cash Bills. and Promissory Notes. 74 (appendix) (1789). 150 2 T.R. 63, 100 E.R. 35. 151 Above note ??? at 40 (T.R), 960-1 (E.R.) The litigants were immediate parties to the transaction so the point was not essential for the determination of the case. 152 Above, note ??? at ???. In that case there was evidence that the maker “was swindled out of the note” probably by the payee. However, “the plaintiff took the note bona fide and gave a valuable consideration for it”. Ibid. 153 Above note ??? at 71 (T.R.), 39 (E.R.) According to this decision. “[t]he rule is founded purely on principles of law and not on the custom of merchants. The custom of merchants only establishes that such an instrument may be indorsed; but the effect of the indorsement is a question of law. . .”. Ibid. 154 ,3 T.R. 80, 100 E.R. 466. 155 The precedent is described as Buller J.’s own decision “in the case in Cornwall” but does not provide further information needed for identification. Ibid. at 82 (T.R), 467 (E.R). Possibly it is “Banks v. Colwell at Launceston at Spring Assizes 1788, before Mr. Justice Buller” mentioned earlier in the report. Ibid. bid. at 81 (T.R), 466 (E.R). 156 Ibid. at 82 (T.R), 467 (E.R). 157 Ibid., Ibid. at 82-3 (T.R). 467 (E.R.)

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held in Brown v. Davies (1789) that the defence of payment before maturity could not be raised against a bona fide purchaser.

Three years later, Lord Loughborough said in Puget de Bras v. Forbes (1792)158

that evidence as to an equity between the drawer and the payee “would be inadmissible had the action been brought by an indorsee for a valuable consideration”.159 This obiter dictum amounts to a complete recognition of the endorsee’s freedom from prior party's defences. In Boehm v. Sterling (1797)160 a bona fide purchaser for value of a cheque recovered from the drawer notwithstanding the latter's defence of failure of consideration. The discussion in that case evolved around the negotiability of a cheque and on whether the plaintiff actually was a bona fide purchaser. It is obvious from the reports that the power of a bona fide purchaser for value of a negotiable instrument to cut off prior party's defences was not even questioned.

Surely, this outline explains the holder’s defence-free position as resting on the

same basis of that of his claim-free position, namely, on the good faith acquisition of value of the instrument. As such, the freedom from prior party’s contract defences, exactly like the freedom from adverse claims, ought to be confined to the bona fide purchaser for value, that is, the holder in due course (“HDC”). At present, the HDC’s claim and defence- free position is codified in BEA Section 38(2). Thereunder, the HDC161 holds the instrument, “free from any defect of title of prior parties, as well as from mere personal defences available to prior parties among themselves, and may enforce payment against all parties liable on the [instrument)”. This includes the right to

1581 Esp. 117, 170 E.R. 298. 159 Ibid. at 119 (Esp.), p. 299 (E.R). 160 2 Esp. 574,. 170 E.R. 460, further proceedings 7 T.R. 423, 101 E.R. 1055. According to Professor Beutel this was the first case or a bill or note where a bona fide purchaser recovered in spite of failure of consideration. F.K. Beutel. “Colonial Sources of the Negotiable Instruments Law of the United States” (1940), 34 Ill. L. Rev. 137, 138 n. 18. But he adds there a reference to “Beawes’ [earlier] confident statement of the Law Merchant to the effect that such defences were cut off”. Lex Mercatoria (1752) 416 s. 14.431 s. 132. Ibid. 161 The conditions for becoming a holder in due course are set out in BEA, above note ???, Section 29(1) as follows: “(1) A holder in due course is a holder who has taken a bill, complete and regular on the face of it, under the following conditions; namely (a) That he became the holder of it before it was overdue, and without notice that it had been previously dishonoured, if such was the fact: (b) That he took the bill in good faith and for value, and that at the time the bill was negotiated to him he had no notice of any defect in the title of the person who negotiated it.” The provision speaks of "bill" but is made applicable to promissory notes by BEA Section 89(1). Cheques are bills: BEA Section 73.

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enforce the instrument free from most prior parties' contractual defences.162 Similarly, in the United States, under the UCC, freedom from (i) any adverse claim, namely, “a claim of a property or possessory right …”,163 as well as from (ii) prior party’s contract defences,164 is reserved to the holder in due course.165

As for the holder not in due course (“HNDC”), namely a holder who becomes a

party to, or acquires, a negotiable instrument without satisfying the holding in due requirements, the position in the United States is not the same as in England. Between the two legal systems, it is American and not English law that draws the logically inevitable conclusion. Thus, at present, according to UCC Section 3-305, an action to enforce a negotiable instrument brought by a HNDC can be met by any “defense … available” in an action for the enforcement of “a right to payment under a simple contract”; the action can also be met by “a claim in recoupment of the obligor against the original payee” arising “from the transaction that gave rise to the instrument …”166 In other words, a HNDC is subject to all defences available to a prior party on the underlying transaction.

Conversely, in dealing with rights of a HNDC, English law effectively adhered to

the autonomy of the obligation on the instrument albeit, in part only. As discussed immediately below, this is reflected by the rules regarding the failure of consideration in the transaction that gave rise to the instrument.167

162 Real or absolute defences, arising “from the invalidity or nullification of the instrument” are not included; hence even a holder in due course takes the instrument subject to them. See Chalmers, above note ??? at 342. 163 UCC, above note 87, Section 3-306. 164 UCC ibid., Section 3-305(b). As in English law, a holder in due course is however subject to ‘real defences’ enumerated in UCC Section 3-305(a)(1). 165 Under UCC ibid., Section 3-302, in principle, “(a) … ‘holder in due course’ means the holder of an instrument if: (1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity; and (2) the holder took the instrument (i) for value, (ii) in good faith, (iii) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series, (iv) without notice that the instrument contains an unauthorized signature or has been altered, (v) without notice of any claim to the instrument described in Section 3-306, and (vi) without notice that any party has a defense or claim in recoupment described in Section 3-305(a).” 166 UCC ibid., Section 3-305(a)(2) and (3) and (b). 167 For a comprehensive critical review, see Geva, Financing, above note 93 at 122-163, particularly, at 152-162.

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In the law of bills and notes “there is a failure of consideration where the

performance is either absent, incomplete, or defective.”168 Failure of consideration is thus interchangeable with the breach of the underlying contract for which the instrument was given. Non-performance, or defective (or incomplete) performance leading to repudiation, is total failure of consideration. Otherwise, “where some benefit has been received,” the failure of consideration is partial.169 Partial failure of consideration may be quantified, namely, in a liquidated amount, as when a seller of goods provided them but not in the entire amount. Alternatively, a failure of consideration may be unquantified, or in an unliqudated amount, as for example where the breach of the contract gives rise to a defence based on unliquidated damages caused by the breach.

In English law, a HNDC, even an immediate party to the underlying transaction,

is allowed to recover the full amount of a negotiable instrument, free from the obligor’s defence of partial failure of consideration in an unliquidated amount. In turn, the obligor is to bring a separate proceeding to recover damages from the immediate party in breach.170 This result is rationalized as premised on the view that a bill of exchange "is itself a contract separate from the [underlying] contract of sale", operating "as a contract in its own right." In that respect, the function of the bill is “ not merely to serve as a negotiable instrument; rather, “it is also to avoid postponement of the purchaser’s liability to the vendor … grounded on some allegation of failure in some respect by the vendor under the underlying contract unless it be total or quantified partial failure of consideration.”171 Effectively then, “[t]he payment by a bill of exchange is to be taken as the payment of so much cash; the defendant ought to satisfy the bill and proceed upon the remedy for the breach of warranty.”172

168 Note, “Failure of Consideration in Negotiable Instruments” (1925), 25 Columbia L. Rev. 83. 169 Ibid. at 86. 170 A classic case is James Lamont &Co. Ltd. v. Hyland Ltd. (No. 2) [1950] 1 All ER (CA), dealing with a the payee-seller’s action against the acceptor-buyer on a ‘trade acceptance’, namely, a bill of exchange drawn by the seller on the buyer, payable to the seller’s order, and accepted by the buyer. The failure of consideration in an unliquidated amount alleged by the buyer-acceptor was not allowed against the seller-payee-holder by way of defence, counterclaim, or even stay of execution. Rather, the buyer-acceptor was required to pay the full amount of the bill and sue the seller in a separate action. 171 See note ??? above. The quote is from Nova (Jersey) Knit Ltd. v. Kammgarn Spinnerei GmbH, ibid. 172 Warwick v. Nairn (1855), 10 Ex. 762, 764; 156 E.R 648, 649.

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Legal doctrine in England can thus be summarized as follows. The freedom of the HDC from contract defences of a remote party is premised on the good faith purchase for value of the instrument by the HDC. At the same time, the freedom of the HNDC from the defence of total or quantified failure of consideration is rationalized on the autonomy of the obligation on the instrument. However, this autonomy of the obligation is not good enough to insulate the HDNC from the defence of unquantified failure of consideration.

Finally, rationalizing the HDC doctrine on the basis of good faith purchase for

value of the instrument, as it is the case in England, has its own limitations. For example, where the payee is a remote party vis-à-vis the acceptor, the former is nevertheless not a purchaser of the instrument; more specifically, in the BEA statutory language, he is not one to whom the bill was “negotiated”, as required to become a HDC.173 Hence, the HDC doctrine cannot explain the payee’s freedom from defences of the acceptor against the drawer.174 This difficulty is bypassed altogether in the Continent; Geneva Uniforms Laws specifically say that parties sued on a negotiable instrument “cannot set up against the holder defences founded on their personal relations” with other parties “unless the holder, in acquiring the [instrument], has knowingly acted to the detriment of the debtor.”175

Also on that point the American UCC improved on English law; thus the UCC

does not require ‘negotiation’ to a HDC; rather, to become a HDC, suffice it for the holder to take the instrument on conditions amounting to good faith and for value.176 Having taken the instrument as so required, the HDC is “not subject to defenses of the obligor … against a person other than the [HDC]” himself.177 Accordingly, under the

173 BEA Section 29(1)(b), reproduced in note ??? above. 174 For the view that the payee, though not a holder in due course, may have similar rights against the acceptor, see N. Elliott, J. Odgers & JM Phillips, Byles on Bills Of Exchange and Cheques, 28th ed. (London: Sweet & Maxwell, 2007) at 237-38. But see Ayres v. Moore, [1940] 1 K.B. 278 at 288 (C.A.), treating the payee as an immediate (rather than remote) party with the acceptor who, as such, is unable to overcome the acceptor’s defence based on third party’s fraud. The locus classicus in English for the proposition that a payee, as an original party to the instrument and not its purchaser, cannot be a holder in due course is RE Jones Ltd. v. Waring and Gillow, Ltd., [1926] A.C. 670. For a discussion on the transformation of the premises of the HDC doctrine to good faith purchase for value, see Chapter 9 text and notes 325-340, above. 175 Article 17 of the Convention Providing a Uniform Law for Bills of Exchange and Promissory Notes, 7 June 1930, 143 L.N.T.S. 257, Annex I, and Article 22 of the Convention Providing a Uniform Law for Cheques, 19 March 1931, 143 L.N.T.S. 355, Annex I. 176 UCC Section 3-302 (a)(2), reproduced in part in note ??? above. 177 UCC ibid., Section 3-305(b). As in English law, a holder in due course is however

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UCC, there is no difficulty in allowing a payee, as a holder in due course, to recover from the acceptor, free from the acceptor’s defences against the drawer.178

In conclusion, the defence-free position of a holder in due course has been

theorized in English law on the good faith for value acquisition of the instrument, so as to facilitate the circulation of the instrument and bring its ‘currency’ quality of the to ‘perfection’. On its own, the unconditional language has not been instrumental in rendering the obligation abstract and autonomous; and yet, in English law, the ‘abstraction’ feature played a limited, albeit somewhat inconsistent role, in determining the rights of a HNDC. The irony is however that the defence-free position reinforced currency for a credit note typically issued by a retail buyer of goods, under circumstances in which the currency of the banknote became irrelevant. Holding-in due-course has been used by assignees of retail sale contracts to confer on them a defence-free position as if they were direct purchase-money lenders to the retail buyers. This has been abused, particularly in cases of a close business connection between financers and vendors; this development, as well as its ramifications, is however, outside the scope of the present discussion.179

4. Conclusion

The transformation of the banking system in England during the 18th and 19th centuries is said to be facilitated by liquidity enhancement in the form of note issuing and bill discounting, practices that appeared in the 17th century and acquired dominance only subsequently.180 This liquidity enhancement facilitated credit expansion in two ways.

First, credit could expand directly, by way of enabling a banker to lend not only

coins but also its own banknotes, and against bills of exchange. Second, this liquidity enhancement also expanded credit indirectly, by allowing one banker extending credit to his own customer to rely on credit extended by another banker to another customer, as reflected in a cheque drawn on the other banker or banknote issued by it. This strengthened the banking system as a whole and facilitated the interbank transfer of credit without reciprocal balances held by one bank with the other.181

subject to real defences enumerated in UCC Section 3-305(a)(1). 178 For the payee as a holder in due course under the UCC, see Official Comment 4 to UCC ibid. Section 3-302. 179 Which is the theme of Geva, Financing, above note 93. 180 FC Lane, “Venetian Bankers, 1496-1533: A Study in the Early Stages of Deposit Banking”, (1937), 45 Journal of Political Economy 187at 187 as well FC Lane, Venice A Maritime Republic (Baltimore: John Hopkins University Press, 1973) at 330. 181 Usher, above note 112, at 20 and 24. This is not to say that the facility may not be abused by overextending credit as argued by B. Hammond, Banks and Politics in

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The key to all this was the circulation of paper. Indeed, the discounting of the bill

of exchange, the payment by means of a banknote, and both the ability to transfer and deposit a cheque, presuppose that these instruments circulate, that is, transferred from hand to hand. Furthermore, enhanced circulation further requires, at least in most circumstances, transferability free of third-party claims and prior-parties defences, namely, transferability of an unconditional claim to the sum embodied in the instrument. The former quality, that of transferability by delivery (with or without endorsement), may be referred to as ‘transferability with a certain facility’ or ‘procedural negotiability’. The second, namely, the transferor’s power to thereby confer to the transferee a better title than that of the transferor, may be referred to as ‘transferability free from equities’ or ‘material negotiability’.

In a pioneering work, Rogers demonstrated that bills and notes had been

accommodated by the common law on its own terms without any importation of new concepts from the Continent.182 In tracing the evolution in English law of material negotiability, reflected in the circulation of commercial paper free from adverse claims and prior parties’ defences, this paper follows suit. It demonstrates the adaptability of common law doctrine to meet new requirements of commerce as they evolved.

America: From the Revolution to the Civil War (Princeton: Princeton University Press, 1957) at 452-453. Though his own example is contested, P. Temin, The Jacksonian Economy (New York: WW Norton, 1969) at 74-77 it is certainly not repudiated in principle. 182 JS Rogers, The Early History of the Law of Bills and Notes: A Study of the Origins of Anglo-American Commercial Law (Cambridge: Cambridge University Press, 1995).

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