Negotiable Instruments in India

Definition and Meaning

A negotiable instrument is a document that provides legal effect and is transferable. According
to Section 13 of the Negotiable Instruments Act, 1881, it encompasses a promissory note, bill of
exchange, or cheque that is payable either to order or to bearer.

Characteristics of Negotiable Instruments

Written: Must be in writing (handwritten, printed, typed, or engraved).
Signed: Must be signed by the maker or drawer.
Unconditional Promise/Order: Contains a clear promise or order to pay a specific amount of
money.
Payable on Demand or at a Specific Time: Must be payable on demand or at a predetermined
time.
Payable to a Specific Person or Bearer: Must be payable to a specific person or their order, or
to the bearer.
Easily Transferable: Can be transferred without much formality, either by delivery or
endorsement.
Certain Time of Payment: Must have a certain time of payment, even if not a specific date.
Certain Payee: Must have a specific person or persons as the payee.

Types of Negotiable Instruments

Promissory Notes

A written promise by one party to pay a specific sum of money to another party, either on
demand or at a predetermined date.

Parties:
Drawer/Promisor (Maker): The person who promises to pay.
Drawee/Promisee: The person in whose favor the note is prepared (often also the payee).
Payee: The person to whom payment is made.

Features:
Written agreement.
Pay a defined amount.
Signed document.
Unconditional promise.
Payment in legal currency.
Detailed information (names, dates, amounts, interest rates, signatures).

Bill of Exchange
A written, unconditional order by one party (drawer) to another party (drawee) to pay a specific
sum of money to a third party (payee) or the bearer, either on demand or at a specified future
date.

Parties:
Drawer: The maker of the bill, who is usually a creditor.
Drawee: The person upon whom the bill is drawn, who is usually a debtor and is also
known as the 'Acceptor' after acceptance.
Payee: The person to whom payment is to be made.

Features:
In writing.
Contains a clear order to pay, not a request.
Unconditional order.
Definite amount.
Fixed date for payment or payable on demand.
Signed by both drawee and drawer.
Payable to a specific person, their order, or the bearer.

Note: When issued by financial institutions, it's often called a bank draft. When issued by an
individual, it's usually a trade draft.

Cheques

A written, unconditional order addressed to a banker, signed by a person who has deposited
money with the banker, requiring the banker to pay a certain sum of money on demand only to
the bearer or to a specified person.

Essentials/Features:
Unconditional order.
Payment always in cash.
Drawn on a particular bank.
Always payable on demand.
Signature by the maker is mandatory.
Amount written in words and figures.
Payable to the person mentioned, their order, or the bearer.
Contains a date (present, prior, or later).
Includes account number, cheque number, MICR code, and IFSC code.

Parties:
Drawer/Maker: The customer or account holder who issues the cheque.
Drawee: The bank on which the cheque is drawn.
Payee: The person named in the cheque who receives payment.
Endorser: The payee who transfers their right to payment to another party.
Endorsee: The party to whom the right is transferred.

Types of Cheques
Bearer Cheque: Payable to the person who carries the cheque. Can be used for cash
 withdrawal and is endorsable. The "OR BEARER" option can be struck out to make it non-
endorsable.
Order Cheque: Payable only to the person whose name is specified on the cheque. The bank
verifies the payee's identity. The "or bearer" is crossed out.
Crossed Cheque: Not payable over the counter. Must be collected through a banker. Marked
by drawing two parallel lines on the top left corner.
Account Payee Cheque: Similar to a crossed cheque but specifically requires the amount to
be transferred directly to the payee's account. Marked with two lines and "A/C PAYEE" on the
left top corner. Prohibits cash withdrawal and is non-transferable.
Stale Cheque: A cheque that is presented for payment after 3 months from its date of issue.
Post-Dated Cheque: A cheque dated later than the date of issue, meaning payment is to be
made on or after the specified future date.
Ante-Dated Cheque: A cheque dated earlier than the current date.
Self-Cheque: A cheque where "SELF" is written in the payee's name, allowing the drawer to
receive cash directly.
Traveller's Cheque: Used for international travel, encashable in foreign countries.
Mutilated Cheque: A torn cheque. If critical information is lost, it's rejected; otherwise, it may
be processed if the drawer confirms.
Blank Cheque: A cheque signed by the drawer but with all other fields left empty.

Crossing of Cheques

Crossing is an instruction to the paying banker to pay the cheque amount only through a banker,
not over the counter. It enhances security and traceability.

General Crossing: Two parallel transverse lines across the face of the cheque, with or without
"and Co." or "not negotiable" between them. Payment is made through any bank.
Special Crossing: The name of a specific banker is written between two parallel transverse
lines. Payment is made only to that banker or their collecting agent.
Restrictive Crossing: Directs the collecting banker to credit the amount only to the account of
the payee or their agent.
Non-Negotiable Crossing: Words "Not Negotiable" are written between the parallel lines. This
does not make the cheque non-transferable but prevents the transferee from acquiring a
better title than that of the transferor. It removes the holder in due course protection.

Demand Drafts (DD)

A pre-paid financial instrument issued by a bank that guarantees payment to the recipient.

Features:
Guaranteed payment.
No signature required from the account holder.
Issued only by banks.
Accepted by many organizations.
Validity period typically 3 to 6 months.

Parties:
Drawer: The person who requests the DD.
Drawee: The bank that pays the money.
Payee: The person who receives the money.
Cheque vs. Demand Draft
Basis Cheque Demand Draft
Issuer Individual, business, or entity from Exclusively issued by banks.
their bank account.
Security Can bounce if funds are Guaranteed payment, pre-paid
insufficient. instrument, less risk of bouncing.
Use Everyday transactions. High-value, secure payments (e.g., fees,
property).
Signature Required from the drawer. Not required from the account holder.
Acceptance May not be universally accepted Widely accepted nationwide; payee
due to bouncing risk. does not need a bank account to
encash.
Stopping Can be stopped by the drawer Cannot be stopped or cancelled by the
Payment under valid circumstances. drawer once issued.
Parties Drawer, Drawee (bank), Payee. Drawer (bank), Payee.
Involved
Additional Generally no charges for issuance; Banks may charge a fee for issuance,
Charges fees for bounced cheques. often based on the draft's value.
Risk Potential security risks if not Higher security; can only be claimed by
"account payee"; risk of bouncing. the designated payee.
Dependability Can be unreliable due to bounced Highly reliable, offering swift and
cheques or clearance delays. secure payment.

Endorsement
The act of signing the back or face of a negotiable instrument by the holder to transfer
ownership or title.

Purpose:
Transfer ownership.
Give the right to negotiate the instrument.
Appoint an agent to receive payment or endorse further.

Endorser: The person who makes the endorsement.

Endorsee: The person who receives the endorsement.
Requirements:
Signature in ink.
Made on the instrument itself or an allonge (attached paper).
Must apply to the entire instrument.
Specific wording is not always required for validity.
Types of Endorsement
Blank or General Endorsement: Only the endorser's signature on the instrument.
Full or Special Endorsement: The endorser's signature plus the name of the endorsee.
Conditional Endorsement: Payment is contingent on the fulfillment of a specific condition.
Restrictive Endorsement: Limits the use of the instrument, making it non-negotiable (e.g.,
"Pay only to X").
Partial Endorsement: Transfers only a portion of the amount or item. Not considered a
negotiation.
Facultative Endorsement: The endorser waives certain rights, such as the right to notice of
dishonour, remaining liable even if notice isn't given.

Significance of Endorsement
Transfers ownership.
Verifies the recipient.
Authorizes the bank to process the transaction.
Can provide assurance of support to third parties.

Regularity of Endorsement

For an endorsement to be regular or valid:

Must be made on the back or front of the instrument.

Must be made by the instrument's creator or holder.
The endorser must sign correctly.
Must apply to the entire negotiable instrument.

Liability of Endorser
Compensation on Dishonour: The endorser must compensate subsequent holders if the
instrument is dishonored by the drawee or acceptor.
Secondary Liability: Liability arises only if the primary obligor fails to pay.
Warranties: Implied warranties include the genuineness of the instrument, good title, and
capacity of prior parties.
Principal Debtor: As between the endorser and subsequent parties, the endorser is liable as a
principal debtor.
Joint and Several Liability: The holder in due course can sue any or all prior parties, including
intervening endorsers.

Dishonour of Cheques
Occurs when a bank refuses to make payment on a cheque.

Reasons for Dishonour

Insufficient funds in the account.
Account closure.
Post-dated cheque presented before its date.
 Mismatch of signature.
Unauthorized changes or alterations to the cheque.
Improper crossing or presentation of crossed cheques.
Errors in account number or cheque details.

Consequences of Wrongful Dishonour

Legal Impact: Can lead to fines or imprisonment under Section 138 of the Negotiable
Instruments Act, 1881.
Financial Setbacks: Bank charges, opportunity costs, and potential legal fees.
Credit Rating Impact: Lowers credit score, affecting future borrowing.
Impact on Trustworthiness: Damages relationships and future dealings.

Section 138 of the Negotiable Instruments Act, 1881

(Cheque Bouncing)

This section deals with cheque bouncing due to insufficient funds or exceeding the account limit.

Process:

1. Bank intimates the payee of dishonour.

2. Payee must make a written demand (cheque bounce notice) to the issuer within 30 days by
post.
3. If the issuer fails to pay within 15 days of receiving the notice, the payee can file a
complaint in court.

Punishment: Imprisonment for not more than two years, or a fine extending to twice the
cheque amount, or both.