Negotiable

Instruments
Updated as of AUG 2020

BANKING AWARENESS

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Negotiable Instruments
• In modern business, large number of transactions involving huge sums of money
takes place every day.

• It is quite inconvenient as well as risky for either party to make and receive
payments in cash.

• Therefore, it is a common practice for businessmen to make use of certain

documents as means of making payment.

• Some of these documents are called negotiable instruments.

• Negotiable instruments are documents meant for making payments, the ownership
of which can be transferred from one person to another many times before the final
payment is made.

• According to section 13 of the Negotiable Instruments Act, 1881, a negotiable

instrument means “promissory note, bill of exchange, or cheque, payable either to
order or to bearer”

• However many other documents are also recognized as negotiable instruments on

the basis of custom and usage, like hundis, treasury bills, share warrants, etc.,
provided they possess the features of negotiability.

• There are 147 different sections in this act. Key sections of this act are as follows:

1. Section 4 deals with Promissory notes

2. Section 5 deals with Bill of Exchange

3. Section 6 deals with Cheque

4. Section 15 deals with Endorsements

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Promissory Note
• Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as ‘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 the order of a certain person or to the bearer of the instrument’

• Lets understand this by simple example, Suppose you take a loan of Rs 10,000
from your friend Soumya.

• You can make a document stating that you will pay the money to Soumya or the
bearer on demand.

• Or you can mention in the document that you would like to pay the amount after
three months.

• This document, once signed by you, duly stamped and handed over to Soumya
becomes a negotiable instrument.

• Now Soumya can personally present it before you for payment or give this
document to some other person to collect money on her behalf.

• He can endorse it in somebody else’s name who in turn can endorse it further till
the final payment is made by you to whosoever presents it before you. This type of
a document is called a Promissory Note.

Parties to a Promissory Note

• There are primarily two parties involved in a promissory note. They are:

1. The Maker or Drawer – the person who makes the note and promises to pay
the amount stated therein. In the above specimen, you are the maker or
drawer.

2. The Payee – the person to whom the amount is payable. In the above
specimen it is Soumya.

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• In course of transfer of a promissory note by payee and others, the parties involved
may be –

I. The Endorser – the person who endorses the note in favour of another
person. In the above specimen if Randhir endorses it in favour of Soumya
and Randhir also endorses it in favour of Nakul, then Soumya and Randhir
both are endorsers.

II. The Endorsee – the person in whose favour the note is negotiated by
endorsement. In the above, it is Randhir and then Nakul

Features of a Promissory Note

• A promissory note must be in writing, duly signed by its maker and properly
stamped as per Indian Stamp Act.

• It must contain an undertaking or promise to pay. Mere acknowledgement of

indebtedness is not enough. For example, if some one writes ‘I owe Rs. 5000/- to
Satya Prakash’, it is not a promissory note.

• The promise to pay must not be conditional. For example, if it is written ‘I promise
to pay Suresh Rs 5,000/- after my sister’s marriage’, is not a promissory note.

• It must contain a promise to pay money only. For example, if some one writes ‘I
promise to give Suresh a Maruti car’ it is not a promissory note.

• The parties to a promissory note, i.e. the maker and the payee must be certain.

• A promissory note may be payable on demand or after a certain date. For example,
if it is written ‘three months after date I promise to pay Satinder or order a sum of
rupees Five Thousand only’ it is a promissory note.’

• The sum payable mentioned must be certain or capable of being made certain. It
means that the sum payable may be in figures or may be such that it can be
calculated.

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Bills of Exchange
• Section 5 of the Negotiable Instruments Act, 1881 defines a “bill of exchange”
as ‘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’.

• Suppose Avneet has given a loan of Rupees Ten Thousand to SImran, which
Simran has to return.

• Now, Avneer also has to give some money to Taniya.

• In this case, Avneet can make a document directing Simran to make payment up to
Rupees Ten Thousand to Taniya on demand or after expiry of a specified period.

• This document is called a Bill of Exchange, which can be transferred to some other
person’s name by Taniya.

Parties to a Bill of Exchange

• There are three parties involved in a bill of exchange. They are

I. The Drawer – The person who makes the order for making payment. In the
above specimen, Avneet is the drawer.

II. The Drawee – The person to whom the order to pay is made. She is
generally a debtor of the drawer. It is Simran in this case.

III. The Payee – The person to whom the payment is to be made. In this case it
is Taniya.

• The drawer can also draw a bill in his own name thereby he himself becomes the
payee.

• Here the words in the bill would be Pay to us or order.

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• In a bill where a time period is mentioned, just like the above specimen, is called a
Time Bill.

• But a bill may be made payable on demand also. This is called a Demand Bill

Features of Bill Exchange

I. A bill must be in writing, duly signed by its drawer, accepted by its drawee and
properly stamped as per Indian Stamp Act.

II. It must contain an order to pay. Words like ‘please pay Rs 5,000/- on demand and
oblige’ are not used.

III. The order must be unconditional.

IV. The order must be to pay money and money alone.

V. The sum payable mentioned must be certain or capable of being made certain.

VI. The parties to a bill must be certain.

Cheques
• Section 6 of Negotiable Instruments Act, 1881 defines a "cheque" as a bill of
exchange drawn on a specified banker and not expressed to be payable otherwise
than on demand.

• Cheque is a very common form of negotiable instrument.

• If you have a savings bank account or current account in a bank, you can issue a
cheque in your own name or in favour of others, thereby directing the bank to pay
the specified amount to the person named in the cheque.

• Therefore, a cheque may be regarded as a bill of exchange; the only difference is

that the bank is always the drawee in case of a cheque

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Features of Cheques

I. A cheque must be in writing and duly signed by the drawer.

II. It contains an unconditional order.

III. It is issued on a specified banker only.

IV. The amount specified is always certain and must be clearly mentioned both in
figures and words.

V. The payee is always certain.

VI. It is always payable on demand.

[Link] cheque must bear a date otherwise it is invalid and shall not be honoured by
the bank.

Various Types of Cheques

1. Bearer Cheque: This type of Cheques is risky in nature for drawer. When the
word “Bearer” on the cheque is not crossed or cancelled, the cheque is called a
bearer cheque. Open / Bearer Cheques are payable to person specified in the
instrument or any person who posses it and present for payment over the counter.
In case of cheque is lost, person who find it can collect payment from the bank.

2. Order Cheque: When the word “Bearer” written on cheque is crossed or cancelled
it becomes an order cheque. An order Cheque is payable to a specified person
named in the cheque or any other to whom it is endorsed.

3. Crossed Cheque or Account Payee Cheque: The person who issue or write the
cheque specify its as account payee by simply making two parallel lines on top left
or middle or right hand corner of the cheque. This type of cheque can not be
encashed over the counter. Considered as safest type of cheque, it can only be
credited to payee’s account whose name is mentioned in the Cheque.

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4. Anti Dated Cheque: Cheque bearing the date earlier than the date of presentation
for payment is known as anti dated cheque.

• Note : All Types of Cheque are valid for three month from the date of issue
(or written on cheque).

5. Post Dated Cheque: Cheque bearing the date which is yet to come in future is
called Post Dated Cheque. Cheque is honored only on or after the date (upto three
months) written on cheque.

6. Stale Cheque: A Cheque turns stale after three months of the date written on
cheque. A Stale Cheque can not be honored by the bank.

7. Mutilated Cheque: When cheque gets torn into two or more pieces and presented
in bank for payment. Such cheques are called mutilated cheque. Bank requires
confirmation by the drawer before honoring such cheques.

Endorsements
• Section 15 of Negotiable Instruments Act 1881 defines a "Endorsement" as
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".

• Endorsement means transfer of any document or instrument to another person by

signing on its back or face or on a slip of paper attached to it.

• An endorsement is the mode of negotiating a negotiable instrument.

• A negotiable instrument payable otherwise than to a bearer can be negotiated only

by endorsement and delivery.

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• According to section 15 of the NIAct “when the maker or holder of a negotiable

instrument signs the same, otherwise than as such marker for the purpose of
negotiation on the back or face thereof or on a slip of paper annexed thereto, he is
said to have endorse the same and is called the endorser.

• The person to whom the instrument is endorsed is called the endorsee.

• Thus usually the endorsement is on the back of the instrument though it may be
even on the face of it.

• Where no space is left on the instrument, the endorsement may be made on a slip
of paper attached to it. This attached slip of paper is called ‘Allonge’.

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