UNIT 2: NEGOTIABLE

INSTRUMENT ACT
What is a Negotiable Instrument?
► A Negotiable Instrument is one, the legal title of which,
can be transferred by mere delivery or endorsement and
delivery. The title thus transferred is free from all defects
and the transferee can sue in his own name.

► Thus negotiability implies easy transferability from one

person to another, in return for consideration.

► Negotiable instruments contain key information such as

principal amount, interest rate, date, and, most
importantly, the signature of the payer.
Negotiable Instruments Act

► In India, the negotiable instruments are governed by the

Negotiable Instruments Act of 1881. The Act simply states
that
“ negotiable instrument means promissory note, bill of
exchange or cheque payable either to order or to bearer”

Thus Negotiable instrument is a document that guarantees

the payment of a specific amount of money to a specified
person (the payee) and requires payment either
on-demand or at a set date.
Features of Negotiable Instruments

► Free transfer
► Transfer free from defects
► Right to sue
► No notice to transfer
► Presumptions as to negotiable instruments
► Credit of the party
Types of Negotiable Instruments

► Promissory notes - A promissory note refers to a written promise

to its holder by an entity or an individual to pay a certain sum of
money by a pre-decided date. In other words, Promissory notes show
the amount which someone owes to you or you owe to someone
together with the interest rate and also the date of payment.

► For example, A purchases from B INR 10,000 worth of goods. In case A

is not able to pay for the purchases in cash, or doesn’t want to do so,
he could give B a promissory note. It is A’s promise to pay B either on
a specified date or on demand.
Types of Negotiable Instruments

► Bill of exchange - Bills of exchange refer to a legally binding,

written document which instructs a party to pay a predetermined sum
of money to the second(another) party. Some of the bills might state
that money is due on a specified date in the future, or they might
state that the payment is due on demand.
► A bill of exchange is used in transactions pertaining to goods as well
as services. It is signed by a party who owes money (called the payer)
and given to a party entitled to receive money (called the payee or
seller), and thus, this could be used for fulfilling the contract for
payment. However, a seller could also endorse a bill of exchange and
give it to someone else, thus passing such payment to some other
party.
Types of Negotiable Instruments

► Cheques - A cheque refers to an instrument in writing which

contains an unconditional order, addressed to a banker and is signed
by a person who has deposited his money with the banker. This order,
requires the banker to pay a certain sum of money on demand only to
to the bearer of cheque (person holding the cheque) or to any other
person who is specifically to be paid as per instructions given.

Definition
“ A bill of exchange drawn on a specified banker and not expressed to be
payable otherwise than on demand.”
Salient features of a Cheque

► Instrument in writing
► An unconditional order on a specified banker
► Payee to be certain
► A certain sum of money
► Payable on demand
► To be signed by the drawer
Precautions before honouring a Cheque
1. Presentation of cheque
i) Type of cheque – generally of two types i.e. open and crossed. If it is
open payment may be made at the counter. If it is crossed payment must
be made only to a fellow banker.
ii) Branch – banker should see whether the cheque is drawn on the
branch where the account is maintained. If it is drawn on another
branch, without any prior arrangement, the banker can return the
cheque.
iii) Account – customer may have two or more accounts in the same
branch. For each account, a separate cheque book would be issued. The
banker must be cautious that a cheque of one account is not used for
withdrawing money from another account.
Precautions before honouring a Cheque

iv) Banking hours – cheque must be presented during banking hours on a

business day. Payment outside banking hours does not amount to
payment in due course.
v) Mutilation – if the cheque is torn or cancelled or mutilated, then the
paying banker should not honour it.
2. Form of the cheque
i) Printed form – the cheque must be in proper form. It must satisfy all
the requirements of law. The customer should draw cheques on the
printed leaves supplied by the bankers, failing which the banker refuses
to honour it.
Precautions before honouring a Cheque

ii) Unconditional order – if it is a conditional the paying banker’s position

will become critical and he may not honour it.
iii) Date – an undated cheque cannot be regarded as a valid instrument.
If it is an ante dated cheque it must be paid if it has not become stale. If
a cheque is post dated banker should honour it only on its due date.
iv) Amount – the amount stated in the cheque both in words and in
figures should be the same. If amount stated only in figures the banker
should return it with the remark “Amount required to be stated in
words”. However if amount is stated only in words,the banker may
honour it. If there is a difference in amount stated in words and figures,
then the banker can follow any of these courses available to him
-Dishonour the cheque with remark “words and figures differ”
-honour the amount stated in words
-Honour the smaller amount
Precautions before honouring a Cheque

v) Material alteration – if there is a material alteration the banker should

return the cheque with the words “Alteration requires drawer’s
confirmation”. If the alteration is confirmed by the drawer by means of
signature, then the banker can honour it.

3.Sufficient Balance-If the funds available are not sufficient to honour

a cheque, the paying banker is justified in returning it.

4. Signature of the Drawer- It is the duty of the paying banker to

compare the signature of his customer found on the cheque with that of
his specimen signature.
5.Endorsement - The banker must verify the regularity of endorsement,
if any, that appears on the instrument.

6. Legal Bar- The existence of legal bar like the Garnishee order limits
the duty of the banker to pay a cheque.
Types of Cheque
Bearer Cheque:

When the words “or bearer” which appear on the face of the cheque are not
cancelled, the cheque is called a bearer cheque. The bearer cheque is payable to
the person specified therein or to any other else who presents it to the bank for
payment.

Order Cheque:

When the word “bearer” appearing on the face of a cheque is cancelled and in
its place the word “or order” is written on the face of the cheque, it is called an
order cheque. Such a cheque is payable to the person specified in that as the
payee, or to anyone else to whom it is endorsed
Bearer Cheque
Uncrossed/Open Cheque:
A cheque is called an “open cheque” when it is not crossed.
It is also known as an “uncrossed cheque”.
Crossed Cheque:
Crossing of cheque means drawing two parallel lines on the
face of the cheque with or without additional words like “&
CO.” or “Account Payee” or “Not Negotiable”.
Anti-dated Cheque:
If a cheque is presented to the bank after the date that is
mentioned on it, it is called as “anti-dated cheque”. Such a
cheque is valid up to 6 months from the date of the cheque.
Post-dated Cheque:
If a cheque bears a date which is yet to come, then it is known as
post-dated cheque. A post dated cheque cannot be honoured earlier than
the date on the cheque.

Stale Cheque:
If a cheque is presented for payment after three months from the date
of the cheque it is called stale cheque. A stale cheque is not honoured by
the bank.
 Circumstances Under Which A Cheque
May Be Dishonoured
A paying banker is under a legal obligation to honour his customer’s
mandate. He is bound to do so under his contractual relationship with his
customer. A wrongful dishonor will have, the worse effect on the banker.
However, under the following circumstances, the payment of a cheque
may be refused.
a) Countermanding: Countermanding is the instruction given by the
customer of a bank requesting the bank not to honour a particular
cheque issued by him. When such an order is received, the banker must
refuse to pay the cheque.
b) Upon receipt of notice of death of a customer: When a banker
receives written information from an authoritative source, regarding the
death of a particular customer, he should not honour any cheque drawn
by that deceased customer.
c) Upon the receipt of notice of insolvency: Once a banker has
knowledge of the insolvency of a customer he must refuse to pay
cheques drawn by him.
d) Upon the receipt of notice of insanity: Where a banker receives
notice of a customer’s insanity, he is justified in refusing payment of the
cheque drawn by him.
e) Upon the receipt of notice of Garnishee order: Garnishee order
refers to the order issued by a court attaching the funds of the
judgement debtor (i.e. the customer) in the hands of a third party (i.e.
the banker). In such a case, the banker may refuse payment.
f) Upon the receipt of notice of assignment: The bank balance of a
customer constitutes an asset and it can be assigned to any person by
giving a letter of assignment to the banker. In such case also the banker
may refuse payment.
g) When a breach of trust is intended: In the case of trust account,
mere knowledge of the customers intention to use the trust funds for his
personal use is a sufficient reason to dishonor his cheque.
h) Defective Title: If the person who brings a cheque for payment has
no title or his title is defective, the banker should refuse to honour the
cheque presented by him.
► Other Grounds: A banker is justified in dishonouring a cheque under
the following circumstances also:
► a conditional one,
► drawn on an ordinary piece of paper,
► a stale one,
► post-dated one,
► mutilated,
► drawn on another branch where the account is not kept,
► presented during non-banking hours.
► If the words and figures differ,
► If there is no sufficient funds,
► If the signature of the customer is forged,
► If the endorsement is irregular and,
► If a crossed cheque is presented at the counter.
Crossing of Cheques
“Drawing Two Parallel Lines” across the front of the cheque. Thus, the crossing is
essential in order that safety is maintained.

A crossing is an instruction to the paying banker to pay the amount of cheque to a

particular banker and not over the counter. The crossing of the cheque secures the
payment to a banker.

A crossed cheque can be made bearer cheque by cancelling the crossing and writing that
the crossing is cancelled and affixing the full signature of drawer.

Generally, cheques are crossed when:

There are two transverse parallel lines, marked across its face, or

The cheque bears an abbreviation “& Co. “between the two parallel lines, or

The cheque bears the words “Not Negotiable” between the two parallel lines, or

cheque bears the words “A/c. Payee” between the two parallel lines.
 Types of crossing

► General Crossing -In general crossing, the cheque bears across

its face an addition of two parallel transverse lines and/or the
addition of words ‘and Co.’ or ‘not negotiable’ between them.
► In the case of general crossing on the cheque, the paying
banker will pay money to any banker. For the purpose of
general crossing two transverse parallel lines at the corner of
the cheque are necessary.
► Thus, in this case, the holder of the cheque or the payee will
receive the payment only through a bank account and not over
the counter. The words ‘not negotiable’ if present are
significant as they restrict the negotiability of the cheque.
 Types of crossing
Special Cheque Crossing -Where a cheque bears across its face in addition
to the name of the banker either with or without the words or the words
‘not negotiable, then the cheque is said to have been crossed specially. The
object of special crossing is to direct the banker to pay the cheque only if it is
presented through the particular bank mentioned.” When a particular bank’s
name is written in between the two parallel lines the cheque is said to be
specially crossed.

In addition to the bank, the words “A/c. Payee Only”, “Not Negotiable”
may also be written. The payment of such cheque is not made unless the bank
named in crossing is presenting the cheque. The effect of special crossing is
that the bank makes payment only to the banker whose name is written in
the crossing. Specially crossed cheques are safer than generally crossed
cheques.
Endorsement
Definition

As per Sec.15 of the NI Act of 1881 “Where 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…, he is said to endorse the
same, and is called the “endorser".

As per the above definition endorsement can be done either on the

back or on the face of the instrument, but according to Sec.6 of the
Indian Securities Act of 1886, an endorsement made on a
document, elsewhere than on the back itself , is not valid.
 SIGNIFICANCE OF ENDORSEMENT
► An endorsement consists of 2 contracts
i. Contract of transfer of property in the instrument, and
ii. Contract of a contingent assumption of liability on the part of the
endorser
The endorser signifies the following to his endorsee and to any
subsequent holder, that when the instrument left his hands –
▪ He had good title to it
▪ It was genuine in all its particulars at the time of his endorsement
▪ All the previous endorsements were genuine
▪ Endorser by his act of endorsing, promises to indemnify the endorsee
or any subsequent holder for any loss suffered by them on dishonour
of the instrument
▪ An endorsement also carries with it a right of further negotiation to
the endorsee, along with the right of ownership
Blank or General Endorsement

In this case, the endorser places only their signature on the negotiable
instrument and does not write the name of a party who will receive the payment.

Full Endorsement or Special Endorsement

The act is special or full when an endorser or transferor signs the instrument
and writes the payee’s name too. As a result, the latter becomes entitled to sue for
the amount payable on the instrument.

Conditional Endorsement

In this case, the endorser places their signature under such writing, which
makes their liability due thereon depending upon the occurrence of a particular
event.
Restrictive Endorsement

This limits the principal features of an instrument and restricts its further
negotiability. Endorsers have the right to prohibit the subsequent transfer of an
instrument. It prevents the risk of the drawer losing their money owing to fraud or
forgery.

Partial

This arrangement allows the transfer of only a portion of the amount payable on an
instrument to the endorsed.

Facultative

Here, the endorser gives up some right to which they have an entitlement. For
instance, endorsements are responsible for giving notice of dishonor to the endorser. In
case they fail to provide this notice, the latter will be free from their liability.

Sans Recourse

This type of endorsement relieves the endorser from all liability against subsequent
holders of the negotiable instrument.
Significance and importance of
endorsement
When it comes to time drafts, endorsement plays a crucial role in ensuring a
smooth and efficient transaction. Endorsement is the act of signing the back of a
time draft, indicating that the signer agrees to pay the amount specified on the
draft at a certain time in the future.

Legal Requirements

Endorsement is a legal requirement for time drafts, as it provides evidence of

the agreement between the parties involved in the transaction. Without
endorsement, the time draft may not be considered a valid legal document,
making it difficult to enforce payment.
Financial security

Endorsement provides financial security for the payee, as it ensures that the
amount specified on the time draft will be paid at the agreed-upon time. This is
particularly important in international trade, where there may be a higher risk of
non-payment or default.

Ease of payment

Endorsement makes it easier for the payee to collect payment on the time
draft, as it allows them to transfer the right to payment to another party if
necessary. This can be especially useful in situations where the payee needs to
raise funds quickly or does not have the resources to collect payment themselves.
Blank endorsement vs. Restrictive
endorsement
Two types of endorsement can be used on time drafts: blank endorsement and
restrictive endorsement. Blank endorsement involves simply signing the
back-of-the-time draft, while restrictive endorsement involves adding specific
instructions or conditions to the endorsement. While blank endorsement is more
common, restrictive endorsement can be useful in situations where the payee
wants to limit the transferability of the time draft.
Paying Banker
The banker who pays by cheque to the customer or the order of the customer is
known as the paying banker. The banker holds the cheque from the drawer and
is obliged to make the payment if the funds of the customer are sufficient to cover
the amount his cheque has drawn.
Duties and Precautions to be taken by the
paying bankers
A proper form of the cheque

Date of the cheque

Amount of the cheque

Material alteration

Drawer’s signature

Mutilated cheque

Balance in customer’s account

Presentation of cheque during working hour

Type of the cheque

Regularity in the endorsement

Account
Statutory Protection to Paying
Banker
► The paying banker is at the statutory obligation to pay cheque amount
out the balance available to his customer and as per the direction of
the customer. The banker runs under greater risk for the payment by
cheque on behalf of the drawer. But the paying banker is provided
protection under certain circumstances of honouring the cheque of his
customer.

► Protection is provided only when the paying banker is acting in good

faith, i.e. honouring cheques in a responsible manner, without
negligence. Sec.85 of the N.I Act, 1881 offers protection to the paying
banker in India.
Payment in Due Course

► According to section 10 payment in due course means “payment in

accordance with the apparent tenor of the instrument , in good faith
and without negligence to any person in possession thereof under
circumstances which do not afford a responsible ground for believing
that he not entitled to receive payment of the amount therein
mentioned.”
► The payment in due course has 3 essential features:
1. Apparent tenor of the instrument – intention of parties
2. Payment in good faith and without negligence
3. Payment to a person who is entitled to receive the payment –
payment to the “holder”
Protection in respect of Materially
altered cheques
Paying banker is protected under section 89 in respect of payment made on a
materially altered cheque if the banker fulfils the following conditions,
► Where a promissory note, bill of exchange, has been materially altered, but
does not appear to been so altered.
► Where the cheque is presented for payment that does not at the time of
presentation appears to be crossed or to have had a crossing, which has been
obtained.
► The instrument is accepted in good faith and the payment is a payment in due
course.
Collecting Banker
A collecting banker is defined as the authority or banker who
receives the bills, cheques, drafts, pay orders, etc., on behalf of the
clients. The liabilities of collecting bankers and the role of
collecting bankers are as agents of collection and holders of value.
Holder for value

A collecting banker becomes a holder for value if he has paid the value of the
cheque to the customer before the cheque is already collected.

As an agent

A collecting banker acts as an agent of the customer on crediting the account

of the customer only after realizing the payment from the paying banker (drawee
bank)

Holder in due course

A holder in due course is any person who receives or holds a negotiable

instrument such as a cheque or promissory note in good faith and in exchange for
value; without any notice or suspicion that it is overdue or was previously
dishonoured.
DUTIES AND RESPONSIBILITIES
OF A COLLECTING BANKER
❖ A Banker must take utmost care while presenting
the cheque for collection.

❖ The collecting banker must present the cheque within a

reasonable time.

❖ Notice to the customer in case of dishonour of cheque.

❖ The banker has to credit the proceeds of the

due to the account of the customer.

❖ Should undertake the collection of cheques only for the

customer and not for strangers.

❖ Must receive the payment as an agent of the customer.

❖ The cheque must be crossed.

Precautions to the taken by the Collecting
Banker while acting as a Holder for a Value

The Collecting Banker has to obtain a consent letter from the customer. The
banker should take an undertaking from the customer, whose cheque has been
received for a value, that the customer will reimburse the banker, in case the
cheque is dishonored.

The collecting Banker must present the cheque for payment within a
reasonable time.

In case of dishonour, within a reasonable time, notice has to be given to all the
concerned endorsers.
Statutory Protection to The Collecting Banker

✔ The Negotiable Instruments Act of 1881, provides some protection to the

collecting banker as he can’t examine every cheque in detail presented for
collection.

✔ Sections 131 and 131 A of the Act deals with the protection given to the
collecting banker.

✔ Section 131 gives protection to the collecting banker in respect of a cheque

bearing a forged endorsement or in respect of a cheque to which the customer
has no title or has a defective title.
Statutory Protection to The Collecting
Banker
✔ This section states that “A banker who has in good faith and without
negligence, received payment for a customer, of a cheque crossed generally or
specially to himself shall not, in case the title to the cheque proves defective,
incur any liability to the true owner of a cheque by reason only of having
received such payment”
The Collecting Banker may claim for
protection under section 131, only if the
following conditions are satisfied:

This protection is available only for a “Crossed Cheque”.

The protection can be claimed only if the cheque is crossed before it reaches
the collecting banker. If the collecting banker receives an open cheque he
crosses it and sends for the payment – the collecting banker can’t get the
protection.

The Collecting banker can claim this protection, only when he has collected
the cheque as an agent for his customer. If he is a holder for value - he can’t
get the protection.
The Collecting Banker may claim for
protection under section 131, only if the
following conditions are satisfied:

This protection can be claimed only if the collecting banker has collected the
cheque in good faith and without negligence. Section 131 A of the Negotiable
Instruments Act of 1881, protects the interests of the collecting banker against
the collection of a ‘bank draft’ having forged endorsement or defective title.
But to get the protection under law all the above-stated conditions must be
fulfilled.
Concept of Negligence

A banker is liable if negligent in dealing with a customer and

causing loss to the customer by paying on forged cheques or delay
in crediting the amount in his account. A wrongful opinion of
creditworthiness or failure to give effect to the instructions of the
customer also makes the bank liable for negligence.