CS Foundation Negotiable Instruments Act, 1881 Notes
→ Negotiable Instrument
According to Section 13(a) of the Negotiable Instruments Act, “Negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer, whether the word “order” or “ bearer” appears on the instrument or not.”
In the words of Justice, Willis, “A negotiable instrument is one, the property in which is acquired by anyone who takes it bonafide and for value notwithstanding any defects of the title in the person from whom he took it”.
A Negotiable Instrument is a:
- written instrument,
- signed by the maker or drawer of the instrument
- it is freely transferable
- the person who obtains it in good faith and for value should get it free from all defects and be entitled to recover the money of the instrument in his own name to a specific person, or to order, or to its bearer
- The holder has a right to sue on the instrument in his own name
- The holder of the instrument is presumed to be owner
→ Classification of Negotiable Instruments:
- Order Instrument: A negotiable instrument that is payable “to the order of’ an identified person or “to” an identifiable person “or order.”
- Bearer Instrument: A negotiable instrument payable “to bearer” or to “cash,” rather than to an identifiable payee.
- Bearer: The person possessing a bearer instrument.
Any instrument payable to the following is a bearer instrument:
- “Payable to the order of bearer”
- “Payable to Jane Smith or bearer”
- “Payable to bearer”
- “Pay cash” or
- “Pay to the order of cash.”
A promissory note, bill of exchange, or cheque drawn or made in India and made payable in, or drawn upon any person resident in India shall be deemed to be an inland instrument.
A promissory note, bill of exchange, or cheque drawn outside India and made payable in. India or outside India shall be deemed to be a foreign instrument or it may be drawn in India and is payable outside India.
If no time for payment is specified, a negotiable instrument is presumed to be payable on demand
An instrument is payable at a definite time if it states that it is payable
- on a specified date,
- within a definite period of time, or
- on a date or at a time readily ascertainable at the time the promise or order is made.
Where an instrument may be construed either as a promissory note or bill of exchange, the holder may at his election treat it as either and the instrument shall be thenceforward treated accordingly.
Incomplete instrument means a signed writing, whether or not issued by the signer, the contents of which show at the time of signing that it is incomplete but that the signer intended it to be completed by the addition of words or numbers.
Under Section 13 of the Act, 3 types of negotiable Instruments are recognized
1. Promissory Note:
Section 4 of the Act defines, “A promissory note is an instrument in writing (note being a bank-note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money to or to the order of a certain person, or to the bearer of the instruments.”
Parties to the Promissory note
- Maker – who makes or executes the note
- payee – one to whom note is payable
- holder – payee or other person whom the note is endorsed
Like most agreements, promissory notes can be tailored to meet your needs. There are, however, certain essential elements of a promissory note.
- writing – Promissory notes must be in writing. There is no such thing as a “verbal” promissory note for Money. A promissory note is valid only if it is a promise to pay money.
- unconditional – The borrower’s payment cannot depend on an event or any other possibility. It must be unconditional.
- specific Amount – The note must indicate a specific amount owed that will be paid.
- express promise – There must be an express undertaking to pay. A mere acknowledgment is not enough
- signed – The person who promise to pay must sign the instrument even though it might have been written by the promisor himself.
- payee must be certain – The instrument must point out with certainty the person to whom the promise has been made
2. Bills of Exchange:
A bill of exchange is a written acknowledgement of the debt, written by the creditor and accepted by the debtor
The Parties to a Bill of Exchange:
- The Drawer – Is the party that issues a Bill of Exchange in an international trade transaction; usually the seller.
- The Drawee – Is the recipient of the Bill of Exchange for payment or acceptance in an international trade transaction; usually the buyer.
- The Payee – Is the party to whom the Bill is payable; usually the seller or their bankers.
Essential conditions of a bill of exchange
- It must be in writing.
- It must be signed by the drawer.
- The drawer, drawee and payee must be certain.
- The sum payable must also be certain.
- It should be properly stamped.
- It must contain an express order to pay money and money alone.
- The order must be unconditional.
→ Types of Bill
(a) Inland bill: Inland bill: A bill is, named as an inland bill if: (a) it is drawn in India on a person residing in India, whether payable in or outside India, or (b) it is drawn in India on a person residing outside India but payable in India.
(b) Foreign Bill: A bill that is not an inland bill is a foreign bill
(c) Trade Bill: A bill drawn and accepted for a genuine trade transaction is termed as a “trade bill”.
(d) Bills in sets: The foreign bills are generally drawn in sets of three and each sets is termed as a ‘via’
(e) Accommodation bill: A bill drawn and accepted not for a genuine trade transaction but only to provide financial help to some party is termed as an “accommodation bill”
(t) Time bill: A bill payable after a fixed time is termed as a time bill. In other words, bill payable “after date” is a time bill.
(g) Demand bill: A bill payable at sight or on demand is termed as a demand bill.
(h) Duplicate Bill: where Bill of Excharge was lost before it was overdue, the person who was the holder to it may apply to the drawer for another Bill of same tenor.
(f) Bank Draft: It is Bill of Exchange drawn by one Bank on another Bank, or by itself on another branch. It is very much similar to cheque but the difference is that it can be drawn by one bank on another Bank. It cannot be made payable to bearer.
Distinction Between Bill of Exchange and Promissory Note:
1. Parties: There are three parties to a bill of exchange, rtamely, the drawer, the drawee and the payee; while in a promissory note there are only two parties – maker and payee.
2. Nature of payment: In a bill of exchange, there is an unconditional order to pay, while in a promissory note there is an unconditional promise to pay.
3. Payment to the Maker: A promissory note cannot be made payable the maker himself, while in a bill of exchange to the drawer and payee or drawee and payee may be same person.
4. Acceptance: A bill of exchange requires an acceptance of the drawee before it is presented for payment, while a promissory note does not require any acceptance since it is signed by the persons who is liable to pay.
5. Primary or absolute liability: The liability of the maker of a promissory note is primary and absolute, but the liability of the drawer of a bill of exchange is secondary and conditional.
6. Protest for dishonour: Foreign bill of exchange must be protested for dishonour when such protest is required to be made by the law of the country where they are drawn, but no such protest is needed in the case of a promissory note.
7. Relation: The maker of the promissory note stands in immediate relation with the payee, while the maker or drawer of an accepted bill stands in immediate relations with the acceptor and not the payee.
8. Notice of dishonour.- In case of dishonour of bill of exchange either due to non-payment or non-acceptance, notice must be given to all persons liable to pay. But in the case of a promissory note, notice of dishonour to the maker is not necessary.
→ Bill of Exchange example:
“Please pay Rs. 500 to the order of ‘A’”
Promissory note example:
“I promise to pay B or order Rs. 500”
A” cheque” is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. Cheque plays an important role in the mechanism of banking. Therefore, cheques are deeply rooted in the relationships of the bank and the customer.
For section 6 of the Negotiable Instruments Act, 1881 (26 of 1881) (hereinafter referred to as the principal Act), the following section shall be substituted, namely:
“Cheque”: A “cheque” is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand and it includes the electronic image of a truncated cheque and a cheque in the electronic form.
Explanation I. For the purposes of this section, the expression
(a) “a cheque in the electronic form” means a cheque that contains the exact mirror image of a paper cheque and is generated, written and signed in a secure system ensuring the minimum safety standards with the use of digital signature (with or without biometrics signature) and asymmetric cryptosystem;
(b) “a truncated cheque” means a cheque which is truncated during the course of a clearing cycle, either by the clearinghouse or by the bank whether paying or receiving payment, immediately on generation of an electronic image for transmission, substituting the further physical movement of the cheque in writing.
Explanation II. For the purposes of this section, the expression “clearing house” means the clearing house managed by the Reserve Bank of India or a clearing house recognised as such by the Reserve Bank of India.’
Drawee. The maker of a bill of exchange or cheque is called the drawer”; the person thereby directed to pay is called the “drawee”.
Essential elements of a cheque are:
- cheques are Bills of Exchange
- drawn on a banker
- payable on demand.
- no stamp is required to be fixed on the cheque
- cheque is usually to be presented within some fix months (6 months in case of India)
- cheque can be drawn on bank where the drawer has an account
- banker is liable only to the drawer
→ A cheque is overdue after three years from its due date of issue Difference between Cheque and Bill of Exchange
- A check is always drawn on a banker although a bill can be drawn on any person or banker.
- A check can only be drawn on demand, although a bill may be drawn payable on demand or on the expiry of a certain period after a specific date.
- In the case of a payment through a check, it does not require any acceptance by the drawee before the payment is demanded. But a bill requires the acceptance by drawee before he is made liable upon it.
- The drawer of a check can make a countermand of payment. But the payment of a bill cannot be countermanded by the drawer.
- A bill of exchange must be duly stamped though the check does not require any stamp.
- Grace period of 3 days is allowed for payment in case of time bills but no grace period in case of cheques.
- No notice of dishonour in case of cheques but a notice of dishonour required in case of bill
→ Banks rights and duties
- Duty to receive money and to collect cheques for his customer’s account
- Duty to honour his customer’s cheques and not to pay without a valid authority
- Duty of secrecy – customer’s accounts
- to honour his customer’s cheques provided that
- Drawn in the proper form
- Credit to an amount sufficient to pay them
- the bankers may only exercise the right of set off when all the relevant accounts are held in the same right
- obligation to give reasonable notice to the customer if the banker wishes to close the account
- obligation to keep proper record of transactions with the customer.
→ Circumstances when Banker may refuse to honour cheques
- when the banker has not sufficient funds of the drawer with him and there is no communication between the bank and the customer to honour the cheque
- cheque is post-dated and the cheque is presented before that date
- payer has stopped the cheque
- When the cheque is not duly presented, e.g., it is presented after banking hours.
- When the cheque is presented at a branch where the customer has no account
- When some persons have joint account and the cheque is not signed jointly by all or by the survivors of them.
- When the cheque has been allowed to become stale
→ When Banker must Refuse Payment
In the following cases he must refuse to honour cheques issued by the customer:
(a) When a customer countermands payment Le., where or when a customer, after issuing a cheque issues instructions not to honour it, the banker must not pay it.
(b) When customer has been adjudged an insolvent.
(c) When the banker receives notice of customer’s insanity.
(d) When an order (e.g., Garnishee Order) of the Court, prohibits payment.
(e) When the customer has given notice of assignment of the credit balance of his account.
(f) When the holder’s title is defective and the banker comes to know of it.
(g) When the banker receives notice of customer’s death.
(h) When the customer has given notice for closing his account .
→ Payment in Due Course:
As per section 10 of the Act, Payment in due course” means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned.
Important provisions relating to payment in due course are the following.
- The payment should be made in accordance with the apparent tenor of the instrument i.e. according to the true intentions of the parties.
- The payment should be made in good faith and without negligence.
- The payment should be made to the person in possession of the instrument in circumstances, which do not arouse suspicion about his title to possess the instrument and to receive payment thereof.
→ Collecting Banker:
The bank undertakes to receive money and to collect bills for its customer’s account.” “Bills”, of course, included cheques since the cheque was and is, a special form of the bill of exchange.
It is for the bank to establish the defence under Section 131. In order to do so, it must show that it collected the cheque:
- for a customer
- in good faith
- without negligence
- it collected a crossed cheque
→ Crossing of cheques:
A crossed cheque is a cheque which is payable only through a collecting banker and not directly at the counter of the bank. Crossing ensures security to the holder of the cheque as only the collecting banker credits the proceeds to the account of the payee of the cheque.
Types of Crossing:
There are two types of negotiable instruments:
- General Crossing
- Special Crossing
- Account Payee or Restrictive Crossing
- ‘Not Negotiable’ Crossing
General Crossing: Where a cheque bean across its face ah addition of:
(a) The words “and company” or any abbreviation thereof between two parallel transverse lines, either with or without the words ” not negotiable or
(b) Two parallel transverse lines simply, either with or without the words “not negotiable”
- Special crossing: Where a cheque bears across its face an addition of the name of a banker, either with or without the words “not negotiable,” that addition constitutes a crossing and the cheque is crossed specially and to that banker.
- Account Payee or Restrictive Crossing: This crossing can be made in both general and special crossing by adding the words Account Payee. In this type of crossing the collecting banker is supposed to credit the amount of the cheque to the account of the payee only.
- Not Negotiable Crossing: The words Not Negotiable’ can be added to General as well as Special crossing and a crossing with these words is known as Not Negotiable crossing. The effect of such a crossing is that it removes the most important characteristic of a negotiable instrument i.e. the transferee of such a crossed cheque cannot get a better title than that of the transferor
→ Maturity of negotiable instruments:
Maturity date is the date on which the payment of an instrument falls due. Every instrument which is payable on specific date has a grace period of 3 days thus if the instrument is payable on 2nd of July then it becomes payable on 5th of July. In case maturity date is on Sunday then the payable date becomes Saturday and not Monday. Grace period of 3 days is not valid for cheques cause they are payable on demand.
- Holder (Section 8) – The “holder” of a promissory note, bill of exchange or cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. Where the note, bill or cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction.
- Holder in due course Section 9 – One holding a negotiable instrument, received for value (he/she paid for it), in good faith and with no suspicion that it might be no good (claimed by another, overdue, or previously dishonoured (a bank had refused to pay since the account was overdrawn). Such a holder is entitled to payment by the maker of the check or note.
→ Liability in case of negotiable instruments
- ection 32. Laibility of maker – The maker of a negotiable instrument, by making it, engages that he will pay it according to its tenor and admits the existence of the payee and his then capacity to indorse.
- Section 30. Liability of Drawer – The drawer of a bill of exchange or cheque is bound in case of dishonour by the drawee or acceptor thereof, to compensate the holder, provided due notice of dishonour has been give to, or received by, the drawer as hereinafter provided.
- Section 31. Liability of drawee of cheque – The drawee of a cheque having sufficient funds of the drawer in his hands properly applicable to the payment of such cheque must pay the cheque when duly required so to do, and, in default of such payment, must compensate the drawer for any loss or damage caused by such default.
- Section 35 Liability of endorser – In the absence of a contract to the contrary, whoever indorses and delivers a negotiable instrument before maturity, without in such endorsement, expressly excluding or making conditional his own liability, is bound thereby to every subsequent holder, in case of dishonour by the drawee, acceptor or maker, to compensate such holder for any loss or damage caused to him by such dishonour, provided due notice of dishonour has been given to, or received by, such endorser as hereinafter provided.
- Section 36 – Liability of prior parties to holder in due course – Every prior party to a negotiable instrument is liable thereon to a holder in due course until the instrument is duly satisfied.
- Section 41 -Acceptor bound, although endorsement forged – An acceptor of a bill of exchange already indorsed is not relieved from liability by reason that such endorsement is forged, if he knew or had reason to believe the endorsement to be forged when he accepted the bill.
- Section 42 – Acceptance of bill drawn in fictitious name – An acceptor of a bill of exchange drawn in a fictitious name and payable to the drawer’s order is not, by reason that such name is fictitious, relieved from liability to any holder in due course claiming under an endorsement by the same hand as the drawer’s signature and purporting to be made by the drawer.
When a promissory note, bill of exchange or cheque is transferred to any person, so as to constitute that person the holder thereof, the instrument is said to be negotiated.
When the maker or holder of a negotiable instrument signs the same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed thereto, or so signs for the same purpose a stamped paper intended to be completed as a negotiable instrument, he is said to endorse the same and is called the “endorser”.
→ Various types of endorsement:
(a) Blank or General: If the indorser signs his name only, the indorsement is said to be in blank
(b) Full or Special: if he adds a direction to pay the amount mentioned in the instrument to, or to the order of, a specified person, the endorsement is said to be in full and the person so specified is called the” endorsee” of the instrument.
(c) Restrictive: when he further adds that it should be paid only to a specific person like Pay A.
(d) Conditional: when the endorsement is conditional which limits the liability of endorser on that particular condition.
- Presentment for acceptance: A bill of exchange payable after sight must, if no time or place is specified therein for
- presentment, be presented to the drawee thereof for acceptance. If the holder fails to present the bill then all the endorsee are discharged from the liability to pay him. The bills which are required to be payable on specific date or on demand are not required to be presented.
Presentment for payment:
Promissory notes, bill of exchange and cheques must be presented for payment to the maker, acceptor or drawee thereof respectively, by or on behalf or the holder as hereinafter provided. In default of such presentment, the other parties thereto are not liable thereon to such holder.
Discharge from liability:
The maker, acceptor or indorser respectively of a negotiable instrument is discharged from liability thereon by cancellation, by release, by payment, by operation of law, by allowing drawee more than 48 hours of bill, by material alteration Dishonour
Dishonour by non-acceptance:
A bill of exchange is said to be dishonoured by non-acceptance when the drawee, or one of several drawee not being partners, makes default in acceptance upon being duly required to accept the bill, or where presentment is excused and the bill is not accepted.
Dishonours by non-payment:
A promissory note, bill of exchange or cheque is said to be dishonoured by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque makes default in payment upon being duly required to pay the same.
A Hundi is an unconditional order in writing made by a person directing another to pay a certain sum of money to a person named in the order. Hundis, being a part of the informal system have no legal status and are not covered under the Negotiable Instruments Act, 1881. Though normally regarded as bills of exchange, they were more often used as equivalents of cheques issued by indigenous bankers. They were used
- as remittance instruments (to transfer funds from one place to another),
- as credit instruments (to borrow money [lOUs]),
- for trade transactions (as bills of exchange).
→ Types of Hundis:
- Shah Jog Hundi: payable only to a respectable holder, as opposed to a hundi payable to bearer.
- Jokhmi Hundi: always drawn on or against goods shipped.
- Jawabee Hundi: used for remitting money from one place to another
- Nam jog Hundi: It is a hundi payable to the party named in the bill or his order
- Darshani hundi: This is a hundi payable at sight
- Miadi Hundi: payable after a specified period of time.