NETGOTIABLE INSTRUMENTS
The negotiable instruments are governed by the
Negotiable Instruments Act 1881.
This act came into force on 1st March 1882.
There are certain documents which are freely used in
commercial transactions.
Negotiable instrument means a written document
which create a right in favour of some person and
which is freely transferable.
Definition of Negotiable Instrument
According to section 13 of the
Negotiable Instruments Act 1881, a
negotiable instrument means “ a
promissory note, bills of exchange or
cheque, payable either to order or to
the bearer whether the words order or
bearer appear on the instrument or
not”.
Characteristics of Negotiable Instruments
[Link]- Negotibility means the transfer of the
right, title and interest of the holder of a negotiable
instrument , so as to give the transferee a good title.
[Link] Writing- A negotiable instrument must be in
writing.
[Link] order or promise- Every negotiable
instrument must contain an unconditional order or
promise for payment.
4. Time of Payment- The time of payment must
be certain.
5. The Payee must be a certain person – The
person whose favour the instrument is made must
be named or described with reasonable certainty.
6. A Negotiable instrument must bear the
signature of its maker- The instrument will be
valid only when it contains the signature of the
drawer or the maker
Types of Negotiable Instruments
Negotiable instruments are classified
into:
1. Negotiable by statute and
2. Negotiable by custom or usage
1. Instruments Negotiable by
Statute-
According to Section 13 of the
Negotiable Instruments Act, there are
only three kinds of negotiable
instruments.
They are: Promissory notes, Bills of
exchange and cheques. These
instruments are negotiable by statute.
Instruments Negotiable by Custom or Usage-
There are certain other instruments which have
got the character of negotiability by usage or
custom of trade.
In India, government promissory notes, bank
drafts and pay orders, delivery orders and railway
receipts for goods etc are treated as negotiable
instruments by usage or custom.
Promissory Notes
According to Section 4 of the Negotiable
Instruments Act 1881 “ A promissory note is
an instrument in writing( not being a bank
note or a currency note) containing an
unconditional undertaking, signed by the
maker, to pay a certain sum of money only
to, or to order of, a certain person or to the
bearer of the instrument “.
The person who makes the promissory
note and promises to pay is called the
maker and the person to whom the
payment is to be made is called the
payee.
Elements of Promissory Note
An instrument must have the following elements to
become a promissory note
1. In Writing- The instrument must be in writing. Mere
verbal engagement to pay is not enough. Writing includes
print and typewriting and may also in ink or pencil.
2. Promises to Pay- The instrument must contain an
express promise to pay. A mere acknowledgement in
indebtness or implied undertaking by the use of the word
or promise is not sufficient.
3. Definite and Unconditional- a promise to pay must be
definite and unconditional. If it is uncertain or conditional
the instrument is invalid.
4. Signed by the Maker- The instrument must be
signed by the maker. Otherwise it is incomplete
and of no effect.
5. Certain Parties- The instrument must point
out with certainty as to who the maker is and the
payee is.
6. Certain Sum of Money- The amount payable
must be certain and must not be capable of
contingent additions or subtractions.
7. Promise to pay money only- If the instrument
contains a promise to pay something in addition to
money it can not be a promissory note.
8. Bank note or currency note is not a
promissory note-
9. Payable on demand or after a definite
period of time- The expression on demand
means the instrument is payable immediately or
forthwith.
Bills of Exchange
According to Section 5 of the Negotiable
Instruments Act 1881, a bill of exchange is “
an instrument in writing containing an
unconditional order, signed by the maker,
directing a certain person to pay a certain
sum of money only to. Or to the order of, a
certain person or to the bearer of the
instrument”.
Parties to a Bill of Exchange
There are three parties to a bill of exchange,
viz, the drawer, the drawee and the payee
1. Drawer- Drawer is the person who makes
the bill. A seller/ creditor who is entitled to
receive money from the debtor can draw a
bill of exchange upon the buyer/ debtor.
After writing the bill of exchange the drawer
is required to sign the bill as maker of the
bill.
2. Drawee- Drawee is the person upon
whom the bill of exchange is drawn. When
the drawee accepts the bill, he is known as
the acceptor.
3. Payee- Payee is the person to whom the
payment is to be made. The drawer of the
bill will be the payee if he keeps the bill with
him till the date of its payment.
Essential Elements of Bills of Exchange
1. It must be in writing
[Link] must contain an order to pay
3. The order must be unconditional
4. It requires three parties ie, the drawer, the
drawee and the payee ( sometimes the
drawer may be the payee also)
5. The parties must be certain
6. It must be signed by the drawer
7. The sum payable must be certain
8. It must contain an order to pay money.
9. Must bear the stamp- Bills of exchange must be
properly stamped in accordance with the Indian
Stamp Act,1899.
Different Classes of Bills of Exchange
1. Inland and Foreign Bill-
A bill which is drawn in India and which is either
payable in India or is drawn on a person resident in
India is known as an inland bill and all other bills
other than inland bills are foreign bills.
An inland bill does not cease to be such because it
is endorsed in a foreign country or is in circulation
therein.
2. Documentary Bill-
These are bills to the shipping documents (such as
bill of lading, railway receipt, invoice, certificate of
origin etc) are attached.
Such bills are usually drawn in triplicate. Such
bills are usually negotiated through a bank which
is instructed to deliver the documents to the
consignee, either against payment of the bill or
against acceptance of the bill.
3. Usance or time bills-
Usance denotes the time fixed by custom
within which bills drawn in one country and
made payable in another country are to be
paid.
This period varies in different countries.
In most of the countries, the period is
generally three months.
4. Accommodation Bills-
A bill of exchange, which does not originate in
pursuance of a commercial transaction like sale of
goods or lending of money and is drawn, accepted
or endorsed without consideration merely to help
a business associate, is referred to an
accommodation bill.
In this case, the acceptor just lends out his name to
the other so that the latter may obtain credit.
Acceptance of a Bill
An acceptance is the signature of the drawee
of a bill who has sighed his assent upon the
bill and delivered it or given notice of such
signing to the holder or to some person on
his behalf.
Only the drawee can be the acceptor, or a
person named as drawee in case of need, or
an acceptor for honour
Difference Between Bills of Exchange and Promissory Note
Basis Bills of Exchange Promissory Note
Parties There are three parties, Only two parties,ie,
drawer, drawee and drawer and payee
payee
Contains An unconditional order Unconditional
promise
Maker Creditor is the maker Debtor is the
maker
Acceptance Require No acceptance is
acceptance by the required
drawee
Immediate relation With the acceptor Immediate relation
by the maker and not the drawee with the payee
Notice of Given to all No notice is
dishonour persons who are to required to the
be made liable maker
Noting and Protesting
When a promissory note or bill of exchange is
dishonoured, the holder can authenticate it by
‘noting’ by a Notary Public.
On noting, a certificate is issued by the Notary.
Such a certificate is called “Protest”. It is the
certificate of attesting the dishonor.
Cheques
According to Negotiable Instruments
(Amendment and Miscellaneous Provisions)
Act 2002 a cheque is “ a bills of exchange
drawn on a specified banker and not
expresssed to be payable otherwise on
demand and it includes the electronic image
of a truncated cheque and a cheque in the
electronic form”
Requisites of a Valid Cheque
1. Must be in Writing-
Always in written form
No restrictions on the materials used for writing
cheques
Pen, pencil or print
Banks discourage using of pencil
2. Contain an Unconditional Oreder
A cheque is an order to pay, but the word
order need not be used in writing a cheque.
If any condition is attached to a cheque, it
loss its identity.
3. Drawn on a specified Banker
Always drawn on a specified banker and not
on any other person.
The drawee of a cheque must be a bank and
the address of the banker must be specified
4. Signed by the Maker
A cheque must contain the signature of the
drawer
The drawer should be the customer of the
bank.
The signature should match with the
specimen signature submitted to the banker
at the time of opening of an account.
5. Payment must be Certainsum of
Money
The sum of money to be paid must be
certain
A cheque can not be used to draw other
things such as securities, documents
etc.
6. Payee must be Certain
Payee is the person to whom the amount
mentioned in the cheque is to be payable.
A cheque is valid only when the payee is
certain.
7. Amount Payable on demand
A cheque is always payable on demand
It is not necessary to use the words ‘on
demand” in the cheque.
Parties of a Cheque
Three parties
1. Drawer
2. Drawee
[Link]
1. Drawer
Drawer is the person who draws or
makes a cheque.
The drawer should have an account
with a credit balance or an overdraft
faility with the drawee bank
[Link]
Specified banker who has been
directed by the drawer to pay the
amount specified in the cheque.
3. Payee
Payee is the person to whom the
amount of cheque is payable.
Usually the name of the payee is shown
on the face of the cheque.
If the cheque is payable to self, the
drawer himself becomes the payee.
Bearer Cheques
A cheque which is payable to the bearer of the cheque
It can be transferred from one person to another by
mere delivery.
No endorsement is needed
It is payable at the bank counter to the person who
brings if for payment.
The signature of the bearer is obtained by the bank at
the time making payment
Order Cheques
Order cheque is payable to a certain person.
The name of the payee should be entered in
the order cheque.
It cannot be transferred from one person to
another by mere delivery.
It requires proper endorsement
MICR Cheque
For speeding up cheque clearance process, Magnetized
Cheque processing system with the help of Magnetic
Ink Character Regognition (MICR) technology.
In MICR cheques, characters are printed in magnetic
ink which contains iron oxide particles that can be
magnitized.
It can be read with the help of an MICR reading
machine.
MICR code contrains the following information-
1. First six numbers indicate cheque number
2. Next three numbers indicate city code
3. Next three numbers indicate bank code
4. Next three numbers indicate branch code
After some space there is the number for transaction
code which indicates the nature of account, whether
current account or savings account
Open Cheque
Cash is available over the counter of the
bank.
The cheque can be endorsed to another
person by signing on the reserve side of
the cheque.
Crossed Cheque
When a cheque is crossed, the payment cannot be
made by the bank over the counter.
The cheque can ony be credited to the account of the
payee
Ante- Dated Cheque
When the drawer of a cheque writes a date
earlier than the date on which the cheque is
actually drawn is called ante- dated cheque.
Such a cheque is consiserd valid
The banker should have no objection in
making payment of such cheques
Post Dated Cheque
A cheque which bears a date later than the date of
issue is called a post- dated cheque.
The cheque can be presented for payment only on or
after the date which bears on the cheque
Stale Cheque
If a cheque is not presented for payment withing a
reasonable period after the date of issue, it is called a
stale cheque.
In India, a cheque is treated as stale cheque after the
expiry of 3 months from the date of the cheque.
Mutilated Cheque
A cheque which is torn into two or more
pieces in such a way that its contents are not
readable by banker.
Banks will not make payment against such a
cheque without getting proper confirmation
from the drawer.
Marking of Cheque
Marking or certification of a cheque
means certifying a cheque as “good for
payment” by the drawee bank.
Marking indicates that the drawer has
drawn the cheque in good faith and
ther is sufficient balance in the account
Electronic Cheque
A cheque in electronic form is known as
electronic cheque
It is generated, written and signed
electronically using digital signature or
biometric signature or encrypted data.
Negotiable Instruments (Amendment)
Act,2002 gives validity to electronic cheques
Material Alteration
Alteration which results in a major change in the
instrument whether it is beneficial or detrimental to
any party to the instrument.
It may be in the form of alteration of the date of
cheque, place of payment, amount of cheque, name of
the payee, cancellation of crossing, changing special
crossing into general crossing and striking off the
words ‘not negotiable’ or ‘ Account payee” from a
general or special crossing.
Holder
Section 8 of the Indian Negotiable
instruments Act defines holder of a
promissory note, bill of exchange or
cheque as “ a person entitled in his own
name to the possession thereof and to
receive or recover the amount due
thereon from the parties thereto”.
Under the following conditions a person can be
treated as a holder:
1. He must have a legal title to the instrument. The
title to the instrument is acquired lawfully and in a
proper and regular manner.
[Link] must be entitled to receive or recover the amount
from the parties of the instrument.
Thus a person who has obtained possession of an
instrument by theft or any other illegal methods is not
a holder of the instrument.
Holder in Due Course
A negotiable instrument can be
transferred from one person to another.
Any person who acquires the title to
the instrument bona fide and for value
is called holder in due course.
According to section 9 of the Negotiable
Instruments Act, holder in due course means “ any
person who for consideration, became the
possessor of a promissory note, bill of exchange or
cheque, if payable to bearer, or the payee or
endorsee thereof, if payable to order, before the
amount mentioned in it became payable and
having without sufficient cause to believe that any
defect exists in the title of the person from whom
he derived his title”
From the definition it is clear that a holder
in due course :
1. Must be in possession of the instrument.
In the case of an order instrument, he must
be its payee or endorsee.
2. Must be in possession of the instrument
before it becomes due. This condition is
applicable to instruments payable otherwise
than on demand.
3. Must obtain possession of the instrument
for a consideration which is legal and
sufficient.
[Link] obtain possession in good faith
without sufficient reason to believe that any
defect existed in the title of the transferor.
Difference Between Cheque and Bills of Exchange
Basis Cheque Bill of exchange
1. Drawn on A printed form Need not be in printed
form
2. Drawee Only a specified Any person
banker
[Link] Not required By the drawee is
compulsory
4. Payment On demand On demand or after a
specified period
5. On No notice is Notice required
Dishonour required
6. Days of Not allowed Allowed
grace
7. Crossing Possible Not possible
8. Stamp Not required Must be properly
stamped
[Link] Drawer can Can not be
countermand countermanded
before the
payment
10. Liability Drawer is liable Drawee is liable
11. Stop payment On receipt of Need not stop
notice of death, payment
insolvency or
insanity of drawer
12Use As a means of As a means of
payment financing business