VOL 18 NO 213 REGD NO DA 1589 | Dhaka, Sunday May 9 2010

Negotiable Instrument Act and cheque used as collateral

M S Siddiqui

All loans in Bangladesh are backed by collateral. Usually, fixed asset, fixed deposits,
Investments, Insurance policies, valuables and bills receivable etc are accepted as
collateral. Borrowers secure loans by mortgaging the assets.

The lenders do conservative valuation of collaterals for secured repayments. The lender
assesses the value of pledged asset at around half of the market value. That way, they
improve their chances of getting all their money back in case theinvestments lose value.

If the assets lose value for any reason, borrowers might have to pledge more assets to
keep collateral loan. Moreover, lenders ask for personal guarantee from the directors of
the borrower company for the loans. Very often the banks take the collaterals and sell
them for less than the amount and put claim against balance amount. The Artho Rin
Adalat Act 2003 is very strict in Bangladesh. Lenders can directly take over the
properties and sell them through auction without court decision. This is a delegated
judicial authority to bankers and may be challenged in the higher court.

There is cooperation among the housing companies, lenders and insurers. Borrowers buy
assets and put as collateral and insurance companies cover the risks. The agreements
authorise the housing companies to pay the loan amount to the financial institution in
case of any dispute or crisis. This understanding among the housing companies,
Insurance companies and financial institutions goes against interest of borrowers,
particularly the poor and middle class borrowers. The loans are more than secured in any
case for lenders.

The loan may be long term and short term on the basis of the length of time of
repayments. The long-term and short-term financing is commonly used to purchase,
improve, or expand fixed assets such as plant, facilities, major equipment, and real estate.
The length of repayment also depends upon the life expectancy of the assets. The short
term loan is often used to raise cash for cyclical inventory needs like raw materials and
working capital. Usually the interest rates on long-term financing tend to be higher than
on short-term borrowing, and long-term financing usually requires more substantial
collateral as security against the extended duration of the lender's risk. But the in some
economy like Bangladesh the interest rate is regulated by Bangladesh Bank for certain
categories of loans. The non banking financial institutes charge high interest rate on short
term loan for all categories of borrowers like businesses and individuals.

Unlike a secured loan, an unsecured loan is also given on promise to pay a debt. The
lender is relying upon the creditworthiness and reputation of the borrower to repay the
obligation. An example of anunsecured loan is a revolving consumer credit card.
Sometimes, working capital lines of credit are also unsecured.

The higher purchase scheme in Bangladesh is also run under unsecured loan. There are
some loan programmes for individual consumers for purchase of households and luxury
products are guaranteed by the employers of borrowers and also some responsible
government officials. This is termed as consumer loans.

The most common type of loan given to small business are: Industrial loan for land,
building and machinery, working capital, short term commercial loan, long term
commercial loan, leasing of machinery and equipment, advance against export letter of
credit etc.

The banks and non banking financial institutions use to ask the borrowers of all
categories of borrowers to issue cheques for full amount of loan and interest and some
blanks cheque for some extra amount. Banks seeks to use these blank or forward dated
cheques as collaterals. These banks and financial institutions sue the borrowers in case of
bouncing of cheques under the clause 138 of Negotiable Instruments Act.

According to international norms, a cheque is a bill of exchange drawn on a bank and

payable on demand. What differentiates a real cheque from a simple 'I owe you (IOU), is
the guarantee that the amount of money specified is available, upon request, from a bank
or some other established institutions.

The advent of cheques in the market has given a new dimension to the commercial and
corporate world. Dealings in cheques are vital and important not only for banking
purposes but also for the commerce and industry and the economy of the country.

The goal of this treatise is to ascertain applicability of Section 138 Negotiable

Instruments Act, 1881 on such transactions, in other words to determine whether
prosecution can be initiated against the drawers in case of dishonour of cheques on such
transactions (when cheques are received or issued as security).

A cheque drawn by a person on an account maintained by him with a banker for payment
of any amount of money to another person from out of that account is returned by the
bank unpaid, either because of the amount of money standing to the credit of that account
is insufficient to honour the cheque or that it exceeds the amount arranged to be paid
from that account by an agreement made with that bank, such person shall be deemed to
have committed an offence and shall, without prejudice to any other provision of this Act,
be punished with imprisonment for a term which may extend to one year, or with fine
which may extend to thrice the amount of the cheque, or with both.
The Negotiable Instrument Act in India has no ambiguity. As per Indian N I Act, the
cheque issued unpaid by the bank must have been issued in discharge of a debt or other
liability wholly or in part. Where a cheque is issued not for the purposes of discharge of
any debt or other liability, the maker of the cheque is not liable for prosecution under
section 138 of the Act. A cheque given as a gift or for any other reasons and not for the
satisfaction of any debt or other liability, partly or wholly, even if it is returned unpaid
will not meet the penal consequences.

If the above conditions are fulfilled, irrespective of the mental conditions of the drawer
he shall be deemed to have committed an offence, provided the other three requisites are
fulfilled:

There is a landmark recent judgement of Mumbai high court that banks cannot prosecute
borrowers under the stringent anti-cheque bouncing laws if blank post-dated cheques
issued by them as collateral security are dishonoured. The judgment as appeared in the
newspaper: ''It is doubtful if the provisions of Section 138 of the Negotiable Instruments

Act can apply to a case in which a blank or post-dated cheque is obtained by a bank or
money lender before or while sanctioning or disbursing loan amounts as security for the
loan,'' said Justice P R Borkar. The order is likely to come as a huge setback to lending
agencies who ask borrowers to deposit blank post-dated cheques as security. ''Law-
makers must not have intended or imagined that money lenders or banks would obtain
blank or post-dated cheques while sanctioning/disbursing loans as securities and would
use them to make debtors/borrowers repay the loan under threat of prosecution and
punishment (under the cheque-bouncing law),'' added the judge.

In another similar case, the court upheld the acquittal of Ahmednagar resident Rajendra
Warma, who was prosecuted after a blank cheque issued by him for a loan was
dishonoured. Ramkrishna Urban Cooperative Credit Society (RUCCS) had given a loan
of Rs 2 lakh to Warma in 2000. Warma had issued 10 blank post-dated cheques at that
time as security. One of these cheques, dated January 2008, bounced, following which
RUCCS lodged a criminal complaint against Warma.

The magistrate's court held that Warma was not guilty under the Negotiable Instruments
Act and acquitted him. It also held that while Warma had receipts to prove that he had
repaid the entire loan amount in 2005, the bank failed to produce records after 2003.

Verdict is likely to be struck down, as Sec 138 of NI Act does not deal on the type of
security and deals only on default on the promise as evidenced by cheque. It is wise to
have fast track courts soon to try bank loans and related cases as stake involved runs to
thousand of crores of public money

Though insertion of the penal provisions have helped to curtail the issue of cheque
lightheartedly or in a playful manner or with a dishonest intention and the trading
community now feels more secured in receiving the payment through cheques. However
there being no provision for recovery of the amount covered under the dishonoured
cheque, in a case where accused is convicted under section 138 and the accused has
served the sentence but, unable to deposit amount of fine, the only option left with the
complainant is to file civil suit.

The provisions of the Act do not permit any other alternative method of realization of the
amount due to the complainant on the cheque being dishonored for the reasons of
"insufficient fund" in the drawer's account. The proper course to be adopted by the
complainant in such a situation should be by filing a suit before the competent civil court,
for realization/ recovery of the amount due to him for the reason of dishonoured cheque
which the complainant is at liberty to avail of if so advised in accordance with law.

It would be relevant to note that the statute does not refer to the debt being payable,
meaning thereby, a post dated cheque for a debt due but payment postponed at a future
date would attract Section 138 of the Negotiable Instruments Act 1881. But the cheque
issued not for an existing due, but issued by way of a security, would not attract Section
138 of the Negotiable Instruments Act 1881, for it has not been issued for a debt which
has come into in existence. A cheque issued as collateral does not create liability under
section 138 of Negotiable Instrument Act since this is not issued against payment of any
liability at the time of issue of cheque. On the other hand the ambiguity of NI Act may be
corrected.

The writer is a part-time teacher, Leading University. He can be reached at e-mail:

shah@banglachemical.com