UNIT-3
INTRODUCTION TO NEGOTIABLE INSTRUMENTS
The documents used as supplements to money, are known as “ negotiable instruments” if they satisfy certain requirements. The word negotiable means transferable by delivery. The word instrument means any document defining certain rights and duties.
NEGOTIABLE INSTRUMENT ACT 1881: Meaning of negotiable instrument
The meaning of negotiable instrument is not provided as such in the Act. It can however be defined according to Sec. 13-“ A negotiable instrument means, a promissory note, bill of exchange or cheque payable either to order or bearer.”
This section talks of only three kinds of instruments, however there can be other kinds too. Characteristics of a Negotiable Instrument
The characteristics of a negotiable instrument may be described as follows:
A negotiable instrument being an instrument is in writing and signed by its maker. A negotiable instrument contains an unconditional promise or order to pay some money. A negotiable instrument is about a fixed amount of money only.
A negotiable instrument is transferable easily from one person to another.
The transferee of an instrument, receiving it in good faith and for value, has the right to recover the amount mentioned in the instrument in his own name. Such a person is called holder in due course.
Presumptions about Negotiable Instrument
Following are the presumptions relating to the negotiable instruments as laid down in Section 118 & 119.
1. Consideration: It is presumed that every NI has been made or drawn or accepted, indorsed, or transferred for consideration. This is true even for subsequent parties. 2. Date: In case of a NI bearing a date, it is presumed that it has been made or
3. Time of acceptance: An accepted bill of exchange is presumed to have been accepted within a reasonable time after being made, and before its maturity (i.e. the due date of payment)
4. Proper time of transfer: It is presumed that every transfer of a NI was made before its maturity.
5. Order of indorsements: It is presumed that the indorsements appearing on the NI have been made in the same order in which they appear on the instrument.
6. Stamp: For a lost NI, it is presumed that it was duly stamped.
7. Holder in due course: It is presumed that every holder of a NI is a ‘holder in due course’. In case of a dispute, the party liable for payment has to prove that the person holding the NI is not the holder in due course.
8. Fact of dishonor: The instrument shall be presumed to have been dishonoured if this allegation is made in court and the fact of protest is proved. In case an instrument is dishonoured, the holder is entitled to file a suit to recover the amount.
KINDS OF NEGOTIABLE INSTRUMENTS:
PROMISSORY NOTE
BILL OF EXCHANGE
CHEQUE
Promissory Note:
A ‘promissory note’ is a promise in writing by a person to pay a certain sum of money to a specified person.
According to section 4: A promissory note is an instrument in writing 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 bearer of the instrument.
The following would be valid promissory notes as they satisfy the requirements of the definition given above:
b. I acknowledge myself to be indebted to B in Rs, 1000, to be paid on demand for value received.
Parties to a Promissory Note:
1. MAKER: This is the person who makes the promissory note and promises to pay the money stated therein.
2. PAYEE: This is the person to whom the amount of promissory note is payable i.e. to whom the promise to pay is made.
Essentials of a Valid Promissory Note:
It must be in writing: To be an instrument, it must be in writing. An oral promise to pay a sum of money may be a valid contract but it cannot become a promissory note. The writing may be in ink or in pencil and includes printing and typewriting.
It must contain an express promise to pay money: An implied promise to pay is not sufficient. The word promise may not be necessarily be used. For eg. S executed an instrument containing the words “I have received a sum of Rs 1000 from B. This amount will be repaid on demand. I have received this amount in cash”. This would be a promissory note as it contains a clear promise to pay.
The promise to pay must be unconditional: This means, the promise to pay should not depend upon a condition, if so it will be invalid. For eg. ‘I promise to pay B Rs. 1000 one month after A’s marriage with C’. It is an uncertain promissory note because A may never marry C.
But, where an instrument is made payable on the happening of a definite event, the instrument is valid. Similarly, a note containing a promise to pay at a particular place or after a specified time is not conditional.
It must be signed by the maker: An instruments is complete when it is signed by the maker. Mere writing in his own hand is not sufficient; his sign ,must be there. If the maker is illiterate, he may put his thumb mark.
It must have promise to pay a definite amount of money. The amount of money stated in the note must be definite and not uncertain. For eg. ‘ I promise to pay B Rs 1000 and fine according to rules.
The parties must be certain. Both the parties, the maker and the payee, must be identified on the face of the instrument. Thus it must be clear as to who is liable to pay the money, and also who is entitled to receive the payment.
Other formalities: There are other formalities such as date, place, attestation etc. which are usually found in promissory note. But they are not essential in law.
BILL OF EXCHANGE:
A ‘bill of exchange’ is an order in writing asking a person to pay a sum of money to a specified person.
According to Sec. 5-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 bill of exchange:
1. Drawer: This is a person who draws the bill of exchange. He is the maker of the bill of the exchange.
2. Drawee: This is the person on whom the bill is drawn, the person who is ordered to pay the amount of the bill of exchange. When the drawee accepts the bill of exchange, he becomes the acceptor. The acceptance of a bill of exchange by the drawee must be in writing only.
3. Payee: This is a person to whom the amount of bill of exchange is payable.
ESSENTIALS OF BILL OF EXCHANGE:
1. It must be in writing and signed by the drawer.
3. The parties of the bill must be certain. 4. It must contain an order to pay money only.
5. It must contain an order to pay a definite amount of money. 6. The order to pay money must be unconditional.
7. Other formalities: In addition to the above, date, place, time, attestation must also be taken into consideration.
CHEQUE:
A cheque is a peculiar kind of bill of exchange. It is a bill of exchange which is drawn upon a banker and is always payable on demand. The amendment in the year 2002 has recognized an electronic cheque also as a cheque.
Definition: According to Sec. 6- ‘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 electronic form’.
A cheque as a bill of exchange has following two additional features: It is always drawn on a specified bank, and
It is always payable on demand. Parties to a cheque:
1. Drawer. This is a person who draws the cheque. He is the maker of the cheque.
2. Drawee. This is the banker on whom the cheque is drawn and who is directed to pay the amount of the cheque.
3. Payee. This is the person to whom the amount mentioned in the cheque is made payable. ESSENTIALS OF A VALID CHEQUE:
It must have all essentials of a bill of exchange being itself a bill of exchange.
It must be drawn on a specified banker. A cheque drawn on any person other than a banker is not valid.
A cheque is not required to be accepted by the drawee bank. It is also not required to be stamped.
NEGOTIATION: It is the process of transferring a NI in the manner intended in a NI
DEFINITION: Sec-14 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.
MATURITY OF NI:
‘Maturity’ of an instrument means the date at which its payment falls due. An instrument made to be payable ‘on demand’ such as cheque, becomes payable immediately on the date of its execution.
Sec. 22 lays down that every promissory note or bill of exchange which is not expressed to be payable on demand is at maturity on the third day after the day on which it is expressed to be payable.
INDORSEMENT:
It is the written order on the instrument by its rightful holder to make the payment to another person.
DEFINITION: SEC-15 When the maker or holder of a NI signs the same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof on the slip of paper annexed thereto, or so signs for the same purpose a stamped paper intended to be completed as negotiable instrument, he is said to indorse the same, and is called the indorser.
The person making the indorsement is called an ‘indorser’ and the person to whom the instrument is indorsed is called an ‘indorsee’.
Requirements for valid indorsement:
The indorser must sign his name in exactly the same manner as it appears on the face of negotiable instrument. If the payee is an illiterate person, he may indorse the instrument by affixing his left hand thumb impression thereon, but a witness is necessary.
Indorsement must be for the entire amount of the instrument.
In the case of joint-holding of an instrument all the holders must sign the indorsement unless one of them has authority to sign as representative to others.
They need not contain the complementary prefixes and suffixes.
In case of married woman, the name of husband must be mentioned in indorsement.
BLANK INDORSEMENT: This is the indorsement done through a mere signature on the instrument without mentioning the name of the indorsee or the transferee. This converts the order instrument into a bearer instrument.
PARTIAL INDORSEMENT: Section 56 provides that a NI cannot be indorsed for a part of the amount appearing to be due on the instrument. A partial indorsement is invalid. An indorsement to transfer the instrument to two or more indorsee’s separately and not jointly for separate amounts is also treated as partial indorsement and hence invalid.
RESTRICTIVE INDORSEMENT:Sec 50 permits restrictive indorsements also. An indorsement which, by express words, restricts or excludes the indorsee’s right of further negotiation or merely constitutes the indorsee as his agent, is called restrictive indorsement. Eg. A cheque indorsed by using the word ‘pay M only’.
CONDITIONAL INDORSEMENT: Where the indorser of the NI, by express words in the indorsement, excludes his liability, or makes is liability or the indorsee’s right of receiving payment dependent on the happening of a specified event, although such event may never happen, such is called conditional indorsement. For eg. ’Pay H if he reaches Delhi’.
HOLDER AND HOLDER IN DUE COURSE:
HOLDER- Sec.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.
The holder in due course must satisfy the following two conditions:
1. He must be entitled to the possession of the instrument in his own name: To be a holder of the instrument, a person must have the right of possession of the instrument under some legal or valid title. This means that a physical possession of the instrument is neither sufficient nor essential. The person must be either the payee or the indorsee of the instrument, or he must be the bearer thereof, if it is a bearer instrument. An assignee of a bill or note under an assignment deed is not a holder because such a person is entitled to possess also in his favour or is payable to bearer. A thief or finder of a lost instrument or an indorsee under a forged indorsement may have the possession of the instrument, but he cannot become its holder because he has not acquired a legal title thereto and is not entitled to have possession thereof in his own name.
2. He must be entitled to receive or recover the amount due thereon: To be a holder, the person concerned must be entitled to recover the amount from the parties liable thereto and give a valid discharge to the payer. An agent or an employee possessing an instrument on behalf of the principal for collection or safe custody does not become the holder of it although he may receive its payment, because he has no right to sue on the instrument in his own name.
The holder in due course is a very rightful holder of an instrument.
DEFINITION: Sec.9- 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 indorsee thereof, if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.
The holder in due course must possess the following qualifications:
He must be a holder, i.e. he must be entitled to the possession of the instrument in his own name under a legal title and to recover the amount thereof from the parties liable thereto. In addition, the holder must have become the holder by fulfilling certain other conditions laid down in the section.
He must become a possessor for valuable and lawful consideration. A person acquiring title to the instrument by way of gift or donation would not be a holder in due course for want for consideration, although he may be a holder.
He must have become the possessor of a negotiable instrument before its maturity. A person who acquires it after the maturity cannot be a holder in due course.
The acquired instrument must, on the face of it, be complete and regular in the technical sense. If it contains nay alterations not authenticated by the drawer through his signature, or if it is incomplete, then the instrument will not be such as to make the possessor a holder in due course.
He must have become holder without having sufficient cause to believe that any defect existed in the title of the transferor. He must not be negligent and should take great care and exercise necessary precautions in scrutinizing the transferor’s title.
DISCHARGE OF INSTRUMENTS AND PARTIES:
The term ‘discharge’ in context of a negotiable instrument would have two implications, namely: 1. Discharge of the instrument, and
2. Discharge of one or more parties from liability on the instrument. Discharge of the instrument:
o When the party primarily liable on the instrument, i.e. the maker of the note or acceptor of the bill or the drawee bank, makes the payment in due course to the holder at or after maturity. A payment by a party who was liable only secondarily would not discharge the instrument, because in that case the party who has paid will hold it to enforce it against prior indorses and the principal debtor.
o When a bill of exchange has, during its negotiation, come into the hands of the acceptor as a holder at or after maturity, the instrument is discharged.
o When the holder cancels the instrument with an intention to release the party primarily liable thereon from the liability, the instrument is discharged and ceases to be negotiable.
o By non presentment of acceptance of bill. When a bill of exchange is payable a stated period after sight, its holder must present it for acceptance to the drawee within a reasonable time after it is drawn. If he makes a default in making such presentment, the drawer and all indorsers who were liable towards such a holder are discharged from their liability towards him. Then, no one remains liable on the bill.
o A NI may be discharged in any manner in which any contract can come to an end. Thus, by a mutual agreement a NI may be discharged.
DISCHARGE OF ONE OR MORE PARTIES:
A party would be discharged from his liability when he is no more liable on the instrument. When only some of the parties to a NI, and not others, are discharged, the instrument continues to be negotiable.
i. BY CANCELLATION: When the holder of a NI deliberately cancels the name of any of the parties, the maker, the acceptor or the indorser, with an intent to discharge him from liability thereon, such party and all the indorsers subsequent to him, who have a right of action against the party whose name is so cancelled, are discharged from liability.
ii. BY RELEASE: This is a situation similar to the previous one in effect although the method mentioned here is release and not cancellation of names. Release may not require cancellation of names but may take place under a separate agreement of waiver.
iii. BY PAYMENT: When the party liable on the instrument makes the payment in due course to the holder at or after maturity, all the parties subsequent to him in the instrument stand discharged.
v. BY DELAY IN PRESENTING CHEQUE: It is the duty of the holder of a cheque to present it for payment within reasonable time of its issue. If he fails to do so and in mean while the bank fails, causing a loss to the drawer, the drawer is discharged as against the holder to the extent of the actual damage suffered by him.