MODULE 5
1. Meaning and Definition of Negotiable Instruments
A negotiable instrument is a written document that creates a right in favour of a person to receive
payment of a certain sum of money either on demand or at a future date. The special feature of
such an instrument is its negotiability, meaning that it can be freely transferred from one person
to another. The transferee can sue in his own name and may obtain a better title than the
transferor if he becomes a holder in due course. Section 13 of the Negotiable Instruments Act,
1881 recognizes three principal negotiable instruments, namely promissory notes, bills of
exchange and cheques. These instruments play a significant role in modern commercial
transactions because they facilitate easy transfer of money and credit in business dealings.
2. Characteristics of Negotiable Instruments
Negotiable instruments possess certain essential characteristics that distinguish them from
ordinary contracts. Firstly, they are freely transferable either by delivery or by endorsement and
delivery. Secondly, the holder in due course obtains a better title than the transferor, even where
defects existed in the transferor’s title. Thirdly, the law presumes consideration, date and
acceptance unless proved otherwise under Sections 118 and 139 of the Act. Another important
feature is that the holder can sue in his own name without notifying previous holders. These
instruments must always be in writing, signed by the maker or drawer, and must contain an
unconditional promise or order to pay a definite amount of money. The amount payable and the
parties involved must also be certain and identifiable.
3. Promissory Note
Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as an instrument in
writing containing an unconditional undertaking signed by the maker to pay a certain sum of
money to a certain person or to his order. It is essentially a written promise to pay. The parties
involved are the maker, who promises to pay, and the payee, who receives the payment. For a
valid promissory note, there must be a clear and unconditional promise to pay, certainty of
amount and parties, and the instrument must be signed by the maker. A mere acknowledgment of
debt does not constitute a promissory note unless there is an express undertaking to pay.
Promissory notes are widely used in commercial and financial transactions as evidence of debt.
4. Bill of Exchange
A bill of exchange is defined under Section 5 as an instrument in writing containing an
unconditional order signed by the maker directing a certain person to pay a certain sum of money
to another person or to his order. Unlike a promissory note, which contains a promise, a bill of
exchange contains an order to pay. The parties include the drawer, who gives the order; the
drawee, who is directed to pay; and the payee, who receives the amount. When the drawee
accepts the bill, he becomes the acceptor and incurs primary liability. Bills of exchange are
commonly used in trade transactions, especially in international commerce, because they
facilitate credit and delayed payments.
5. Cheque
A cheque is a special type of bill of exchange defined under Section 6 of the Act. It is always
drawn on a specified banker and is payable on demand. The parties to a cheque are the drawer,
the drawee bank and the payee. Unlike ordinary bills of exchange, cheques do not require
acceptance by the bank before payment. Various kinds of cheques exist in banking practice, such
as bearer cheques, order cheques, crossed cheques, post-dated cheques and stale cheques.
Cheques are one of the most commonly used negotiable instruments because they provide
convenience and security in commercial transactions.
6. Parties to Negotiable Instruments
Different negotiable instruments involve different parties. In a promissory note, the parties are
the maker and the payee. In a bill of exchange, the important parties are the drawer, drawee,
acceptor and payee. In a cheque, the parties are the drawer, drawee bank and payee. Additional
parties may also arise through negotiation, such as endorsers and endorsees. The rights and
liabilities of these parties depend upon the nature of the instrument and the capacity in which
they sign it.
7. Presentation of Cheques
Presentation means submitting the cheque to the bank for payment. A cheque must be presented
within a reasonable time and during banking hours. If the cheque is not presented within the
prescribed validity period, it becomes stale and the bank may refuse payment. Proper
presentation is essential because delay may discharge the drawer if he suffers loss due to such
delay. Under Section 138 proceedings relating to dishonour of cheques, timely presentation of
the cheque is one of the mandatory requirements for criminal liability.
8. Negotiation of Negotiable Instruments
Negotiation refers to the transfer of a negotiable instrument from one person to another in such a
manner as to constitute the transferee the holder thereof. Section 14 provides that negotiation
may occur by delivery or by endorsement and delivery. Bearer instruments are negotiated merely
by delivery, whereas order instruments require endorsement followed by delivery. Negotiation is
the feature that gives negotiable instruments their commercial utility, as they can circulate freely
like money in business transactions.
9. Endorsement
Endorsement means signing the instrument for the purpose of negotiation. Under Section 15, the
maker or holder signs either on the back or face of the instrument to transfer it to another person.
Endorsements may be blank, full, restrictive, conditional or sans recourse. A blank endorsement
merely contains the signature of the endorser and converts the instrument into a bearer
instrument. A restrictive endorsement limits further transfer, while a sans recourse endorsement
excludes the endorser’s liability. Endorsement plays an important role in determining rights and
liabilities of parties.
10. Discharge of Negotiable Instruments
A negotiable instrument may be discharged in several ways. The most common mode is payment
in due course by the maker, acceptor or drawee. Discharge may also occur through cancellation
of the instrument, release of liability by the holder, material alteration without consent, or merger
when the principal debtor becomes the holder. Once discharged, the instrument ceases to be
negotiable and all liabilities under it come to an end.
11. Dishonour of Negotiable Instruments
Dishonour occurs when the instrument is not accepted or paid. Dishonour by non-acceptance
mainly applies to bills of exchange when the drawee refuses acceptance. Dishonour by
non-payment occurs when payment is refused upon maturity or presentation. Dishonour gives
rise to civil liability and, in the case of cheques, may also lead to criminal liability under Section
138 of the Act. Notice of dishonour must generally be given to prior parties to hold them liable.
12. Crossing of Cheques
Crossing is a direction to the banker that payment should be made only through a bank and not
across the counter. Crossing provides security against fraud and misuse. General crossing
consists of two parallel transverse lines on the cheque, while special crossing includes the name
of a specific banker. Restrictive crossings such as “Account Payee Only” further ensure that
payment is credited only to the payee’s account. A “Not Negotiable” crossing restricts the
transferee from obtaining a better title than the transferor.
13. Effect of Crossing
The effect of crossing is to increase the safety of cheque transactions. A crossed cheque cannot
ordinarily be encashed over the counter and must pass through a bank account. This minimizes
the possibility of theft or unauthorized encashment. In the case of special crossing, payment can
only be made through the banker named in the crossing. The “Not Negotiable” crossing destroys
the characteristic of transfer of better title, while “Account Payee” crossing restricts payment to
the specified payee’s account.
14. Holder and Holder in Due Course
A holder under Section 8 is a person entitled in his own name to possess and recover the amount
due on the instrument. A holder in due course under Section 9 is a person who acquires the
instrument for consideration, before maturity and in good faith. The holder in due course enjoys
special privileges, such as obtaining a better title than the transferor and protection against
certain defects in title. The law strongly protects holders in due course to encourage confidence
in commercial transactions.
15. Rights of Holder in Due Course
The holder in due course possesses superior rights compared to an ordinary holder. He can sue
all prior parties and recover the amount even if there were defects in earlier transactions.
Previous parties are estopped from denying the validity of the instrument against him. The law
presumes consideration and lawful transfer in his favour. These protections make negotiable
instruments reliable tools in commercial dealings.
16. Civil and Criminal Liability for Dishonour of Cheques
Dishonour of cheques may lead to both civil and criminal liability. Civil liability arises when the
payee files a suit for recovery of money, damages or interest. Criminal liability is created under
Section 138 of the Negotiable Instruments Act, 1881. For criminal liability to arise, the cheque
must have been issued towards a legally enforceable debt or liability, presented within validity,
dishonoured by the bank, followed by a statutory notice within 30 days, and failure of payment
within 15 days of receipt of notice. The punishment may extend to imprisonment for two years
or fine up to twice the cheque amount or both.
In Rangappa v. Sri Mohan, the Supreme Court held that there is a statutory presumption in
favour of the existence of legally enforceable debt. In Modi Cements Ltd. v. Kuchil Kumar
Nandi, it was held that stop payment instructions may still attract liability under Section 138. In
Laxmi Dyechem v. State of Gujarat, the Court ruled that dishonour due to “account closed” or
similar reasons may also constitute an offence under Section 138.
17. Paying Banker
A paying banker is the banker who pays the cheque drawn by a customer. The banker has a duty
to verify the customer’s signature, ensure that the cheque is properly drawn, check material
alterations and confirm sufficient funds. Payment must be made according to crossing
instructions. If the banker acts negligently, he may be liable to the customer for wrongful
payment. However, Sections 85 and 128 provide statutory protection to paying bankers when
payment is made in due course and in good faith.
18. Collecting Banker
A collecting banker is a banker who collects cheques on behalf of customers. The banker must
act honestly and without negligence while collecting cheques. The banker must verify
endorsements and follow crossing instructions carefully. Section 131 grants statutory protection
to collecting bankers who act in good faith and without negligence. If negligence is proved, the
banker loses protection and may become liable for conversion.
In Canara Bank v. Canara Sales Corporation, the bank was held liable for negligence in dealing
with forged cheques. In Indian Overseas Bank v. Industrial Chain Concern, the Supreme Court
clarified that statutory protection is available only when the banker acts without negligence.
19. Conclusion
Negotiable instruments constitute an essential part of modern commercial law and banking
practice. They facilitate trade, provide security in financial transactions and ensure smooth
circulation of credit. The Negotiable Instruments Act, 1881 establishes comprehensive rules
regarding creation, transfer, dishonour and enforcement of such instruments. The law relating to
holders in due course, banker’s liability and criminal dishonour of cheques has evolved
significantly through judicial interpretation. For examination purposes, students should focus on
statutory provisions, distinctions between various instruments, procedural requirements under
Section 138 and leading judicial decisions.