Something (usually greenbacks or the local equivalent) that the State declares must be accepted as a form of payment for debts. (This is controversial because it puts private currency at a severe competitive disadvantage -- see seignorage and fiat money -- not to mention interfering with the freedom of contract.) Proponents point out that it helps guarantee a uniform standard of payment within a particular country.

Legal Tender in the United Kingdom is defined as a " means of payment that should not be refused by a creditor in satisfaction of a debt. "

Legal tender is in a somewhat confused state in the United Kingdom, and has been for many years, possibly for the entire existence of the Union.

To summarise:

• English notes, issued by the Bank of England (and in times gone by occasionally the Treasury), are legal tender only in England, Wales, the Channel Islands and the Isle of Man. This is because under the Currency and Bank Notes Act 1954 (before decimalisation of the currency, when each pound was worth significantly more than it is now), Bank of England notes were only legal tender in Scotland for values under £5. Now, the lowest denomination note that they issue is the £5 note.
• Scottish notes, as issued by the Royal Bank of Scotland, the Bank of Scotland, and the Clydesdale Bank, are not legal tender anywhere, including Scotland.
• Notes from Northern Ireland, similar to Scottish notes, are not legal tender anywhere including Nothern Ireland itself.
• Coins, of all denominations, are legal tender all over the United Kingdom, with certain caveats.
  • 1p and 2p coins are legal tender up to the value of 20p;
  • 5p and 10p coins are legal tender up to the value of £5;
  • 20p and 50p coins are legal tender up to the value of £10; and
  • £1, £2, £5 (rare and commemorative) and gold coins of the realm are legal tender to any denomination.

Confusing?

Well, not as much as it appears. For a start, nobody really knows this: it's not well publicised (and hence enforced). I've had a great deal of trouble finding out specifics on this. Also, and more importantly, the status of legal tender isn't as important as it appears.

Let me explain this a bit further. You may pay for your goods or services with cash; you may however pay by other means, such as with a Visa card, a cheque, Switch, or with a large bag of chickens, if the payment method is accepted. Therefore the legal tender status of that crisp twenty in your hand is not nearly as important as whether the person you wish to give it to will accept it as payment.

It should be noted that although it is a rarity, it's is not at all unheard of for Scottish and Northern Irish notes to be refused as payment in England (and no doubt other parts of the UK too). In this situation, alas, you have no legal basis to rely on, and will have to use diplomacy or legal tender instead.

---

Citations:
Scottish law online: http://www.scottishlaw.org.uk/lawscotland/banks.html
Scottish Currency: http://www.saor-alba.fsnet.co.uk/currency.htm
Philately and Numismatics: http://www.cartref.demon.co.uk/eng/collect.htm
Bank of England: http://www.bankofengland.co.uk/banknotes/legaltender.htm
Scottish Banks: http://www.scotbanks.org.uk/