Bachelor of Business Administration

Business Law
(For BBA Students)

Unit - III: Negotiable Instrument Act (1981)

Definition of negotiable instruments, features, promissory note, bill of exchange and
cheque, holder and holder in due course, crossing of a cheque, types of crossings,
negotiation dishonor and discharge of negotiable instrument.
Objective of the Unit
The basic objective of this unit is to make student understand about the concept of
Negotiable act and what are the various instruments comes under negotiable
instrument act. Apart from that, the unit also discuss the various types of cheques
used in personal and as well as business purpose. In how many ways the cheques can
be crossed and issued has also been discussed in this unit.

Introduction
Negotiable Instrument, in law, a written contract or other instrument whose benefit can
be passed on from the original holder to new holders.The original holder (the transferor)
must countersign the instrument (as in the case of a cheque) or merely deliver it (as in
the case of a bank note) to the new holder; the new holder is then entitled to the benefit
of the instrument (in the case of a cheque, to the money from the bank; in the case of
the bank note, to the sum promised on the note).
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”.

Major features of negotiable instruments are;

 Easy Transferability- A negotiable instrument is freely transferable. Usually, when
we transfer any property to somebody, we are required to make a transfer deed, get it
registered, pay stamp duty, etc. But, such formalities are not required while
transferring a negotiable instrument. The ownership is changed by mere delivery
(when payable to the bearer) or by valid endorsement and delivery (when payable to
order). Further, while transferring it is also not required to give a notice to the
previous holder.
 Title-Negotiability confers absolute and good title on the transferee. It means that a
person who receives a negotiable instrument has a clear and undisputable title to the
 instrument. However, the title of the receiver will be absolute, only if he has got the
instrument in good faith and for a consideration. Also, the receiver should have no
knowledge of the previous holder having any defect in his title. Such a person is
known as holder in due course.
 Must be in writing-A negotiable instrument must be in writing. This includes
handwriting, typing, computer printout and engraving, etc.
 Unconditional Order- In every negotiable instrument there must be an
unconditional order or promise for payment.
 Payment- The instrument must involve payment of a certain sum of money only and
nothing else. For example, one cannot make a promissory note on assets, securities,
or goods.
 The time of payment must be certain- It means that the instrument must be
payable at a time which is certain to arrive. If the time is mentioned as ‘when
convenient’ it is not a negotiable instrument. However, if the time of payment is
linked to the death of a person, it is nevertheless a negotiable instrument as death is
certain, though the time thereof is not.
 The payee must be a certain person- It means that the person in whose favour the
instrument is made must be named or described with reasonable certainty. The term
‘person’ includes individual, body corporate, trade unions, even secretary, director
or chairman of an institution. The payee can also be more than one person.
 Signature- A negotiable instrument must bear the signature of its maker. Without
the signature of the drawer or the maker, the instrument shall not be a valid one.
 Delivery- Delivery of the instrument is essential. Any negotiable instrument like a
cheque or a promissory note is not complete till it is delivered to its payee. For
example, you may issue a cheque in your brother’s name but it is not a negotiable
instrument till it is given to your brother.
 Stamping- Stamping of Bills of Exchange and Promissory Notes is mandatory. This
is required as per the Indian Stamp Act, 1899. The value of stamp depends upon the
value of the promote or bill and the time of their payment.
 Right to file suit- The transferee of a negotiable instrument is entitled to file a suit
in his own name for enforcing any right or claim on the basis of the instrument.
 Notice of transfer- It is not necessary to give notice of transfer of a negotiable
instrument to the party liable to pay.
 Presumptions- Certain presumptions apply to all negotiable instruments, for
example consideration is presumed to have passed between the transferor and the
transferee.
 Procedure for suits- In India a special procedure is provided for suits on
promissory notes and bills of exchange.
 Number of transfer- These instruments can be transferred indefinitely till they are
at maturity.
 Rule of evidence- These instruments are in writing and signed by the parties, they
are used as evidence of the fact of indebt ness because they have special rules of
evidence.
 Exchange- These instruments relate to payment of certain money in legal tender,
they are considered as substitutes for money and are accepted in exchange off goods
because cash can be obtained at any moment by paying a small commission.

Various Types of Credit Instruments

Credit Instruments:
People talk a little regretfully of the good old days when everybody was honest and a
man’s word was as good as his written bond. They forget that now the area of dealings
has increased greatly.
Perhaps, man has become more selfish too, on account of the increase in the struggle for
existence; hence almost always some record of transactions is kept in black and white.
This record may take the form of a promissory note, a bill of exchange, a cheque, a
draft or a Hindi.
Banks, in some countries like Great Britain, used to issue notes without check from
Government. These bank notes were of the nature of promissory notes. This led to over-
issue of such notes without sufficient security and resulted in frequent bank failures.
This practice was too dangerous to be allowed to continue and the government had to
prohibit it. Hence today only the Central Bank of a country is allowed to issue notes.
These notes are accepted by the people because of their faith in the stability of the
government, and are almost as good as money. Therefore, for purposes of our study, we
may exclude them from the list of instruments of credit. By instruments of credit ate
meant those documents which make possible credit transactions. Let us study the main
types of credit instruments.
Promissory Note:
The simplest form of a credit instrument is the promissory note. A promissory note (or
pro-note for short) is a written promise from a buyer or a borrower to pay a certain sum
of money to the creditor or his order. It is what we call IOU (I owe you), i.e., an
acknowledgment of debt and an obligation to repay.
A typical promissory note is as below:

The words “value received” indicates that the document is the result of some purchase
or loan. Interest must be mentioned; otherwise the pro-note is not good in law. Such a
document can be used for any kind of transaction, personal or commercial.

Essentials of Valid Promissory Note:

A Promissory note to be valid and enforceable, the following essentials are to be
satisfied:
1. The Promissory note must be in writing:
2. It must contain a promise/undertaking to pay certain sum of money:
3. The promise must be unconditional and certain:
4. It must be duly signed and delivered by the maker:
5. The parties must be certain:
6. It must be stamped according to the provisions of the stamp Act, 1940.
1. The Promissory note must be in writing:
Object of this requirement is to exclude oral engagements to pay from the purview of
the Act. But it is immaterial whether the writing is in ink or in pencil. The term
"writing' includes printing, engraving, lithographing, typewriting etc. There is no
prescribed form for validity of Promissory note provided the requirements of the
definition are complied with. Further the writing may be on any material - paper,
parchment, account book, etc.
2. It must contain a promise/undertaking to pay certain sum of money:
It must not be a mere acknowledgement of debt without an express promise to pay. An
instrument to be valid Promissory note must have an undertaking to pay a sum. Thus,
the writing "I owe you Rs.500", "I am liable to pay" or "I am bound to pay", constitutes
only acknowledgements of liability to pay and cannot treated or dealt with us
Promissory note.
I promise to pay Rs. 5000/- three months from this day to Mr. Modi or bearer or order
for value received. This is the correct form of Promissory note as it clearly expresses
the Promise to pay.
3. The promise must be unconditional and certain:
A Promissory note must contain an unconditional undertaking to or promise to repay.
The payment of money should not be made to depend upon contingency, certainly is
absolutely necessary in the commercial world. A conditional instrument will not be
negotiable even after the fulfilment of the condition.
An instrument which contains, "I promise to pay C Rs.100 on the 31st December, 1940,
provided the war ends towards the end of November 1940", cannot constitute a
Promissory note, as it does not contain an unconditional undertaking to pay the sum
mentioned therein. But a promise to pay B Rs.500 one month after the death of C is a
valid promise because death is a certainly So unconditional promise.
4. It must be duly signed and delivered by the maker:
The Promissory note is incomplete without the signature of its maker. The object of the
signature is to authenticate and give effect to the contract contained in the document.
This signature can be made in any part of the document. This may be done even with a
pencil. If the maker cannot write his name, he may sign by thumb mark.
5. The parties must be certain:
It is of utmost importance that the Promissory note should point out with certainty the
person who enters the contract and engages or undertakes to pay. Several persons may
make a Promissory note jointly and severally. Where a Promissory note is drawn in the
form "I promise to pay" and is signed by two or more persons it is deemed to be their
joint and several note.But Promissory note cannot be made in alternative form. Thus a
Promissory note running as "I.A.B. promise to pay" and signed by "A.B. or else C.D."
is not a good note as regards C.D. but is good note as against A.B.
6. It must be stamped according to the provisions of the stamp Act 1940.
Bill of exchange:
A bill of exchange is used in internal as well as foreign trade. It is an order by a seller to
a buyer or by a creditor to a debtor to pay a certain sum of money to himself or to
bearer or to another person named therein. The seller or the creditor who draws the bill
is called the ‘drawer’; the purchaser or the debtor on whom the bill is drawn is called
the “drawee.” The seller may order the payment to be made to a third person called the
“payee”.

FEATURES OF BILLS OF EXCHANGE

1. It is an instrument in writing.
2. It contains an unconditional order to pay. It means that no conditions can be
attached for making the payment.
3. It mainly involves three parties: Drawer, Drawee and Payee. In most of the cases,
the Drawer and Payee are the same person as the Drawer draws the bill in his/her
own favour. However, it must be remembered that the Drawer and Drawee cannot be
same person (It’s very stupid of me to mention it but I have noticed that it helps in
better understanding).
4. The Parties to bills of exchange must be certain.
5. The Drawer (a.k.a. the Maker) must sign the bill.
6. The amount of money to be paid must be certain.

PARTIES TO BILLS OF EXCHANGE

1. DRAWER OR MAKER
Drawer is the person who draws (or makes) the Bill. He is the person who is entitled to
receive the money (i.e. the Creditor). He is required to sign the bill and send it to the
drawee for acceptance.
2. DRAWEE
Drawee is the person on whom the bill is drawn. He is the person who owes the money.
The Drawee has to accept the bill of exchange drawn by the drawer. Acceptance is done
by signing his name across the face of the bill. Acceptance of the bill denotes that the
drawee has agreed to pay the amount mentioned in the bill on the maturity of the bill or
on demand, as the case may be.
3. PAYEE
Payee is the person to whom the money is payable. In most cases the drawer of the bill
is himself the payee.
4. DRAWEE IN CASE OF NEED
If the drawer has a doubt that the original drawee will not accept or dishonour the bill,
he may write the name of another person for accepting the bill in case the original
drawee does not accept it (You may think him to be a backup for the drawee).
If the bill is not honoured by the original drawee, the bill must be presented to the
drawee in case of need.
EXAMPLE:
Mr C is a trader of cosmetics. He sells goods to Mr D worth Rs 30,000 on credit. Mr G
is the mutual friend of Mr C and Mr D and he has assured Mr C that Mr D has a good
creditworthiness. Upon his assurance Mr C made the sale on credit with a credit period
of two months.
After making the sale, Mr C draws a bill on Mr D for Rs 30000 payable after 2 months
from the date of the bill.
Below you can see the specimen of the Bill drawn by Mr C.

In the above example:

 Mr C is the creditor and drawer of the bill
 Mr D is the debtor and drawee of the bill
 Tenure of Bill is two months
 A certain amount i.e. Rs30000 is to be paid by the drawee
 Mr C is the payee here. The words “or his order” after Mr C in the bill denotes that
Mr C can endorse the bill in favour of someone who will, upon such endorsement,
become the payee of the bill.
Now assume that Mr C has also written the name of Mr G (the mutual friend who
assured the creditworthiness of Mr D) on the bill as Drawee in case of need. In such
case, if the bill is not accepted or dishonoured by Mr D (original drawee) then it would
be presented to Mr G for acceptance and payment. If Mr G also refuses to accept or pay
then the bill will be considered as dishonoured.
TYPES OF BILLS OF EXCHANGE

TYPES OF BILLS OF EXCHANGE

As shown in the above image, Bills of Exchange are normally of two types:
1. BILLS OF EXCHANGE PAYABLE AT SIGHT
These types of bills are payable on demand and the drawee has to pay the amount when
the bill is presented to him for payment.
2. BILLS OF EXCHANGE PAYABLE AFTER A CERTAIN PERIOD OF TIME
These bills become payable after a certain period of time.
In the example we took above, the bill was payable after two months and so it will fall
in this category. These types of bills are also called Term Bills.
DATE OF MATURITY/ DUE DATE OF A BILL OF EXCHANGE
The date on which the amount of a bill becomes payable is called its due date or
maturity date. The following points must be kept in mind in relation to the due date or
maturity date:
1. A Bill ‘Payable at Sight’ becomes due immediately when it is presented for
payment.
2. THREE DAYS OF GRACE are added to the date on which the term of the bill
ends. This is a done as a custom. Three days of grace are not available for a bill payable
on demand.
In the example taken above, the date on which the bill was drawn is 6th October, 2017
and the tenure is 2 months. So the due date would be 6th December, 2017 + 3 days of
grace which comes to 9th December, 2017.
3. When the tenure of the bill is mentioned in days, the calculation of due date must be
made on the basis of days.
4. When the tenure of the bill is mentioned in months, the calculation of the due date
should be made month wise ignoring the actual number of days in a month.
So a bill drawn on 1st January for 3 months will mature on 1st April + 3 days of grace
i.e. on 4th April. Please note that here we are ignoring the actual number of days in the
month and counting 1st Jan to 1st Feb as one month and so on.
5. If the due date turns out to be a public holiday, the due date shall be considered to be
the preceding day. However, if the preceding day is also a public holiday then the
working day proceeding the previous day would be considered the day of maturity.
6.After Date &After Sight: Go to the above image of the bill of exchange and notice
the words “Two months after date “. The words after date mean that the bill will
mature after two months from the date on which the bill is drawn.
In case the bill mentions the words “after sight” instead of “after date” then the period
(i.e. tenure) of the bill shall be counted from the date on which the bill was accepted
by the drawee.
IS A CHEQUE A BILL OF EXCHANGE?
You must have heard of a Cheque which is drawn on a bank by a person who wants to
make payment using funds in his bank account.
Do you think that a Cheque is also a bill of exchange? If your answer is yes then you
are on the right track.
According to Section 6 of the Negotiable Instruments Act, 1881
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 the electronic form.
Thus a Cheque is bill of exchange with the following restrictions:
 it is always drawn on a banker; and
 it becomes payable only on demand.
Hundis:
We, in India, are more familiar with hundis as they are commonly used. They are
internal bills of exchange in one of our own languages, and have been prevalent in India
long before the dawn of civilization elsewhere. Hundis are Darshani (sight bills) and
Miadi or Muddati (time bills) on the basis of the time allowed to the debtor. Hundiana is
the commission sometimes deducted by the lender from the amount advanced.
Specimens of the two types of hundis used in India (translated in English) are
given below:

Difference Between Bill of Exchange & Promissory Note

In continuation of our series of bill of exchange and Promissory Note, today we are
presenting to you the difference between both of them. Hope you like the post!!!
(1) Parties.
There are three parties to a bill of exchange, namely, the drawer, the drawee and the
payee; while in a promissory note there are only two parties – maker and payee.
(2) Nature of payment.
In a bill of exchange, there is an unconditional order to pay, while in a promissory note
there is an unconditional promise to pay.
(3) Acceptance.
A bill of exchange requires an acceptance of the drawee before it is presented for
payment, while a promissory note does not require any acceptance since it is signed by
the persons who is liable to pay.
(4) Liability.
The liability of the maker of a promissory note is primary and absolute, while the
liability of a drawer of bill of exchange is secondary and conditional. It is only when the
drawee fails to pay that the drawer would be liable as a surety.
(5) Notice of dishonour.
In case of dishonour of bill of exchange either due to non-payment or non-acceptance,
notice must be given to all persons liable to pay. But in the case of a promissory note,
notice of dishonour to the maker is not necessary.
(6) Maker’s position.
The drawer of a bill of exchange stands in immediate relationship with the acceptor and
not the payee. While in the case of a promissory note, the maker stands in immediate
relationship with the payee.
(7) Nature of acceptance.
A promissory note can never be conditional, while a bill of exchange can be accepted
conditionally.
(8) Copies.
A bill of exchange can be drawn in sets, but a promissory note cannot be drawn in sets.
(9) Payable to bearer.
A promissory note cannot be made payable to a bearer, while a bill of exchange can be
so drawn provided it is not payable to bearer on demand.
(10) Payable to maker.
In a promissory note, the maker cannot pay to himself. While in the case of a bill of
exchange, the drawer and the payee may be one person.
(11) Protest.
Foreign bills must be protested for dishonour when such protest is required by the law
of the place where they are drawn. But no such protest is required in the case of a
promissory note.
 CHAPTER: 2
Cheques
Definition:
A cheque is the most common instrument of credit and almost works like money. It is a
written order on a printed form by a depositor (drawer) to his bank to pay a sum of”
money to himself or to somebody else, whose name is entered on it, or to the bearer,
i.e., the man who holds it (i.e., drawee) No bank ordinarily refuses to pay money for a
cheque, provided it is correctly filled in, and there is enough money in the drawer’s
account with the bank. A specimen cheque is given below. The counterfoil with the
drawer serves as a record of the payment.
Cheques are of the following kinds:
Advantages of Cheques:
The cheque has economized the use of money. No cash need be paid. Moreover, its
great convenience lies in that the payment can be exact to a paisa. There is no fear of
loss when the cheque is crossed. Thus it is safe method of payment, besides being
convenient. Again, the counterfoil of the cheque serves as a receipt and, therefore,
ensures honesty.
The account of the transaction is with the bank and can be called for evidence, if
needed. But it requires confidence in the drawer as well as the bank for acceptance.
Since cheques are not legal tender, their acceptance is not compulsory.
Bearer Cheque
A cheque which is payable to a person whosoever bears, is called bearer cheque.
 The cheque sometimes can be made payable to “Cash” or bearer or made payable to
a specific name, for example, “bujjisekhar or Bearer”.
 This cheque is payable by the drawee bank over the counter to the Bearer or
presenter of the cheque.
 A Bearer cheque can be negotiated or pass to another person by mere delivery. In
other words, the holder (or the Transferer), when giving it to another person need not
endorse the cheque.
 No identification is needed when a bearer cheque is presented for encashment.
However, in normal banking practice, where the amount of the cheque is substantial,
the identity of the encasher is insisted on.
 A bearer cheque can be collected by the bank for the credit of anyone’s account
 In banking practice, the need for the encasher’s signature on the back of the cheque
is merely to evidence that the encasher has received the money from the bank.
Order Cheque:
A cheque which is payable to a particular person or his order is called an order cheque.
 This is a cheque whereby the printed word “Bearer” on the cheque is cancelled. The
cancellation of the word “Bearer” automatically makes the cheque an “order”
cheque.
 An order cheque can be paid to the named payee across the bank’s account if so
presented.
 Identification must be insisted on by the bank when encasing the order cheque for
the presenter. The ID number and the named payee’s signature will be asked for on
the back of the cheque.

Crossed Cheque:
A crossed cheque is one which has two short parallel lines marked across its face.
 A cheque which carries too parallel transverse lines across the face of the cheque
with or without the words “I and co”, is said to be crossed.
 Crossed cheques are of two types. By simply crossing a cheque or with the words”
& Co”, by the payer, the payee can either deposit it in his/her account or endorse it
in favour of another person on the reverse. This practice is nowadays not accepted
by the banks.
 The advantage of crossing is that it reduces the danger of unauthorised persons
getting possession of a cheque and cashing it. A crossed cheque can only be cashed
through a bank of which the payee of the cheque is a customer.
 A cheque crossed generally will be paid to any bank through which it is presented.
 A cheque crossed specially will be paid only when it is presented for collection by
the bank named between the parallel lines. Such crossing affords a greater measure
of protection against loss.

Account Payee Cheque

When two parallel lines along with a crossed made on the cheque and the word
‘ACCOUNT PAYEE’ written between these lines, then that types of cheques are called
account payee cheque.The payment of the account payee cheque taken place on the
person, firm or company on which name the cheque issue.
Stale Cheque
Check presented at the paying bank after a certain period (typically six months) of its
payment date. A stale check is not an invalid check, but it may be deemed an ‘irregular’
bill of exchange. A bank may refuse to honour it unless its drawer reconfirms it
payment either by inserting a new payment date or by issuing a new check. Also called
stale dated check.
*NOW __The cheque which is more than three months old is a stale cheque.
E.g. If Mr.Cool issues cheque to Miss. Bujji, if Mr. Cool has issued cheque from his
SBI A/c then SBI is a drawee bank.
The banking regulation Act has not define specific period after which the instrument
(cheque) becomes stale. Some of the banks write specific instruction on the cheque
where the validity period is mentioned. In such case the cheque will become stale after
expiry of the period from the date of issue (date on the instrument)
Post Dated Cheque:
If a cheque bears a date later than the date of issue, it is termed as post-dated cheque.
Any check or draft that has a future date written upon it by the user. The amount of the
check will not be drawn from the account until the date written on the check. For
example, a check written on the 14th of the month but dated for the 28th will not be
cashed for another two weeks.

Bank Drafts:
A cheque can also be used to remit funds to another place. But as the account is held in
a different place, from where the cheque is presented, the latter branch of the bank
normally gets in touch with the former before making the payment. To avoid this
botheration, a banker’s draft is used.
A bank draft is a cheque drawn by a bank on its own branch or on another bank
requiring the latter to pay a specified amount to the person named in it or to the order
thereof. The cheapest method of sending money is through a bank draft. A bank does
not usually charge more than 10 P. per hundred rupees if the amount to be sent is not
less than a thousand rupees, and if it has a branch at the place of payment.
 Difference between Promissory Note and Cheque

No Cheque Promissory Note

1 Meaning of Cheque- Meaning of Promissory Note-
A cheque is an order to a bank to pay A promissory note is an unconditional
a stated sum from drawer's account, promise in writing made by one person
written on a specially printed form. to another, signed by the maker,
engaging to pay on demand or at a fixed
or determinable future time, a sum
certain in money to the order of a
specified person, or to bearer.
2 Definition- Definition-
According to Section 6 of According to Section 4 of the
Negotiable Instrument Act 1881, a Negotiable Instrument Act 1881
cheque is a bill of exchange drawn “Promissory Note” is an instrument in
on a specified banker and not writing (not being a bank-note or a
expressed to be payable otherwise currency-note) containing an
than on demand. 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.
3 There are three parties namely- In Promissory Note, there are two
parties namely-
1) Drawer,
1) maker and
2) Drawee and
2) Payee
3) Payee
4 It can be drawn only by the account A promissory note can be made by any
holder of a bank. person.
5 In a cheque, an order for payment is In a promissory note, there is a promise
given to the bank to pay.
6 A cheque is payable always on It may be payable on demand or after a
demand. specified time
7 Grace time- Grace time -
Three days of grace are not given in Three days of grace are given in
a Cheque promissory notes payable after a
specified time.

8 The drawer and payee may be the The maker and the payee/drawer may
same person. not be the same person.
9 No stamps required to be affixed. In a promissory note, stamps are
required to be Affixed.

10 Cheque can be crossed. Crossing of the promissory note is not

required.

Clearing House:
One great advantage that follows from the use of cheques is that we do not have to carry
a pocketful of notes or coins for our purchases. In countries, where people have
developed the banking habit, rarely is a purchase paid for in cash, unless it is a very
small sum. The people who are paid in cheques do not get them cashed but just pay
them into their accounts at their bank. Thus, if both the persons have a common bank, a
mere change in their bank balances completes the transaction.
When there are several banks in a locality and the two persons have accounts with
different banks, the process is not so simple. Every bank receives during the course of
the day cheques on other banks in favour of its customers. To send cash back and forth
from one bank to another every day would be very troublesome. To avoid this trouble,
the device of a Clearing House is used.
The representatives of the local banks meet at a fixed place after the working hours and
balance their claims against one another. When simple book entries have cancelled most
of the obligations, a small balance may be claimed by one bank from the other.
This is usually settled through a cheque on the Central bank (the Reserve Bank of India
or the State Bank of India) with which all commercial banks have to keep accounts.
There are Clearing Houses in important cities in India, the most important being those
in Bombay, Calcutta and Delhi.
Advantages of Credit:
The services rendered by credit to society are undoubtedly very great.
The following benefits of credit may be mentioned:
1. Credit instruments replace metallic money to some extent. This means a great
economy. Expenditure is avoided on precious metals for monetary purposes. Also,
there is no loss arising from wear and tear of coins.
2. Trade and industry are financed mostly by the aid of credit. No industrial or
commercial progress would be possible if the business were to be conducted strictly
on a cash basis. In the absence of credit, trade would be on a very restricted scale.
3. Credit makes capital more productive. It is through credit that capital is transferred
from persons who cannot use it themselves to persons who are in a position to do so.
Without credit facilities, a good deal of capital would have remained unused.
4. Credit enables banks to lend far beyond their cash reserves. Thus they are able to
make profits for themselves besides helping trade and industry. The banks can in this
way ‘create money’.
5. Credit instruments like bills of exchange facilitate payments not only between
people living in the same country, but also between people belonging to different
countries. This facilitates and extends international trade.
6. Men of enterprise and business ability are enabled by credit to launch business
undertakings, even though their own financial resources may be meagre. In this way,
credit helps the development of trade and industry in the country. Without its aid, a
good deal of business talent would have been wasted.
Abuses of Credit:
Credit is a very delicate instrument, and, as such, it has to be handled with utmost care.
Unless the use of credit is kept within sensible limits, it is/likely to prove very
dangerous.
The following possible evils-of credit’ may be mentioned:
1. Reckless borrowing ruins both the borrower and the lender. A spirit of gambling is
introduced in business. This is against the spiritual healthy trade.
2. By making it easy for a person to get funds, credit may encourage extravagance and
waste. People start living beyond their means. This is indeed a very bad habit.
3. If the banks create credit beyond proper limits, it may encourage speculation. Over-
speculation may endanger the economic stability of the country. It stands in the way
of healthy development of trade and industry.
4. Free use of credit by the manufacturers may lead to over-production, causing
depression in the industry. Depression brings business to a standstill. It causes
unemployment and brings misery to the workers.
5. Unsound businesses are kept alive by the artificial aid of credit. It is in the interest of
the community that such weak links should be removed. Credit may only conceal the
financial weakness of a concern.
6. Credit encourages the formation of monopolies by placing large funds at the disposal
of a few individuals or corporations. Monopolies exploit consumers and indulge in
so many other anti-social practices.
 CHAPTER 3
Dishonour
Dishonour is of 2 kinds:
1. Dishonour of bill of exchange by non-acceptance
2. Dishonour of promissory note, bill of exchange or cheque by non-payment
When presentment for payment is made and the maker, acceptor or drawee, as the case
may be, makes default in making the payment, there is dishonour of the instrument.
And also if there are certain circumstances when presentment for payment is excused
and the instrument is deemed to be dishonoured even without presentment. Thus, when
the maker, acceptor or drawee intentionally prevents the presentment of the instrument
is deemed to be dishonoured even without presentment.
NOTICE OF DISHONOUR
Notice of dishonour means information about the fact that the instrument has been
dishonoured.
Notice of dishonour is given to the party sought to be made liable and, therefore it
serves as a warning to the person to whom the notice is given that he could now be
made liable.
Enormous delay in giving notice of dishonour may put an end to the plaintiff’s right in
respect of the dishonoured instrument.
NOTICE OF DISHONOUR BY WHOM?
Notice of dishonour is to be given by a person who wants to make some prior party of
his liable on the instrument. Therefore, such a notice may be given:
1. Either by the holder
2. A party to the instrument who remain liable for it
DISHONOUR OF CHEQUE
A person suffers a lot if a cheque issued in his favour is dishonoured due to the
insufficiency of funds in the account of the drawer of the cheque. To discourage such
dishonour, it has been made an offence by an amendment of the Negotiable Instrument
Act by the Banking, Public Financial Institution and Negotiable Instrument Laws
(Amendment) Act, 1988.
A new Chapter VII consisting of Sections 138 to 142 has been inserted in the
Negotiable Instrument Act.
Section 138 makes the dishonour of cheque an offence. The payee or holder in due
course can have recourse against the drawer, who may be held liable for the offence.
Under Section 138-
Where any 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 for the
discharge, in whole or part, of any debt or other liability, 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 [a term may be extended to 2 years], or with fine
which may extend to twice the amount of the cheque, or with both.

ESSENTIAL FOR AN ACTION UNDER SECTION 138

There should be dishonour of cheque
Section 138 makes dishonour of cheque in certain cases an offence. Cheque is the most
common mode of making the payment. In order to duly protect the interest of its payee,
holder in due course, there is an attempt to discourage dishonour of a cheque by making
it an offence. These provisions do not cover the dishonour of other negotiable
instruments.
Payment in discharge of debtor liability
The cheque should have been drawn by a person on an account with a banker for
payment of money to another person for the discharge, in whole or part, of any debt or
other liability.
The debt or other liability in such a case means a legally enforceable debt or other
liability.
If the payment by way of cheque is made as gift or charity, it is not the payment for
legally enforceable debt or liability. The dishonour of such cheque does not attract the
provisions of Section 138 of the Negotiable Instrument Act.
Presentment of the cheque within the period of its validity
It is further necessary that the cheque has been presented before it became stale and
invalid. It means that the cheque has been presented within a period of 6 months from
the date on which it is drawn or within the period of validity, whichever is earlier.
Dishonour due to insufficient fund
It is also necessary that the cheque should be returned by the bank unpaid.
Dishonour may be because of 2 reasons:
1. Either the amount of money present in the account is insufficient
2. Or the amount to be paid has exceeded the amount to be paid from that account as in
the agreement made with that bank.
It has been generally held in various cases that dishonour due to the insufficiency of
funds has to be interpreted liberally. Dishonour due to the remarks like “Account
closed”, “Refer to the drawer” or “Stop payment” of the cheque may be deemed to be
covered by the provision contained in Section 138 of the Act.
Notice and demand from the drawer and drawer’s failure to pay
Within 15 days of receipt of information from the bank about the dishonour of the
cheque, the payee or holder in due course of the negotiable instrument, as the case may
be, must make a demand of the said amount from the drawer by giving a notice in
writing.
In spite of such a notice the drawer of the cheque should fail to make the payment of the
said amount of money to the payee or the holder in due course of the cheque, within 15
days of the receipt of the said notice.
In the case of TomyJacobKattikaran v. Thomas Manjaly A.I.R 1998 S.C. 366
The Supreme Court has held that if it was established that the appellant did not serve a
notice on the drawer within the period prescribed under Section 138 of the Act, the
acquittal of the drawer is justified.
CIRCUMSTANCES IN WHICH A BANKER IS JUSTIFIED IN
DISHONOURING CUSTOMER’S CHEQUE
PAYMENT COUNTERMANDED BY THE DRAWER
When the cheque drawer of the cheque countermands the payment that is it issues the
instruction to the bank not to make the payment. On receipt of a valid stop payment
order, the cheque must be returned unpaid with the remark “payment countermanded by
drawer“
NOTICE OF DRAWER’S DEATH
On receipt of the confirmed news of death of account holder, cheques signed by him
should be returned unpaid with the remark “Drawer deceased”.
NOTICE OF CUSTOMER’S INSANITY
Where the account holder is certified as insane by a recognised medical practitioner
then the cheques signed by him should be signed by him should be returned unpaid.
NOTICE OF CUSTOMER’S INSOLVENCY
Where a customer is adjudged insolvent, the banker must refuse to pay cheques drawn
by the customer.
 LIQUIDATION OF COMPANY
When a bank receives notice from the liquidator in accordance with the provisions of
Companies Act, requiring to pay the balance to liquidator’s account, all the cheques by
the companies should be returned unpaid.
OFFENCE BY COMPANY
A juristic person like incorporated companies and partnership firms are also made liable
for the offence of dishonour of cheque described under section 138.
Under Section 141-
 If the person committing an offence under section 138 is a company, every person who,
at the time the offence was committed was in charge of, and was responsible to the
company for the conduct of the business of the company,as well as the company, shall
be deemed to be guilty of the offence and shall be liable to be proceeded against and
punished accordingly.
Provided that nothing contained in this sub-section shall render any person liable to
punishment if he proves that the offence was committed without his knowledge, or that
he had exercised all due diligence to prevent the commission of such offence
Provided further that where a person is nominated as a Director of a Company by virtue
of his holding any office or employment in the central Government or State
Government or a financial corporation owned or controlled by the Central Government
as the case may be, he shall not be liable for prosecution under this chapter.
 Notwithstanding anything contained in sub-section (1), where any offence under this
Act has been committed by a company and it is proved that the offence has been
committed with the consent or connivance of or is attributable to, any neglect on the
part of, any director, manager, secretary, or other officer and shall also be deemed to be
guilty of that offence and shall be liable to be proceeded against and punished
accordingly.
Explanation- For the purpose of this section-
1. “Company” means anybody corporate and includes a firm or other association of
individuals; and
2. “Director” in relation to a firm, means a partner in the firm
Section 141 covers 3 categories of person liable for offence under Section 138-
1. The company as principal offender
2. Persons who were in charge and were responsible for the business of company
 3. Any other person who is director or a manager or secretary or officer of the company
There must be a specific accusation against each of the persons alleged as accused
that such person was in charge of and responsible for the conduct of the business of
the company or the firm at the relevant time when the alleged offence was
committed by the company or the firm.The Supreme Court has categorically held
that there has to be specific averment in the complaint to the effect that such a
person was not only in charge of and responsible to the company for the conduct of
its business but it was also required to be stated as to how and in what manner he
was so responsible.
COGNIZANCE OF OFFENCES
Section 142 of Negotiable Instrument Act of 1881 deals with cognizance of offences.
CONDITION ESSENTIAL FOR COGNIZANCE
For initiating proceedings against the drawer of dishonoured cheque drawee has to fulfil
following conditions –
1. The payee or the holder in due course has to file a written complaint.
2. The complaint is to be made within one month of the date on which the cause of
action arose under clause (c) of the proviso to Section 138
3. Only the court of Metropolitan Magistrate or a Judicial Magistrate of First Class is
empowered to try the offence defined under the provision of Section 138.
LIABILITY OF A DRAWER OF A DISHONOURED CHEQUE
 Civil liability
Where a cheque is dishonoured, the legal position of the drawer of the cheque becomes
that of a principal debtor to the holder. The holder can bring civil suit just like any
creditor to recover the amount from the drawer making him liable as principal debtor.
 Criminal liability
A drawer of a cheque is deemed to have committed a criminal offence when the cheque
drawn by him is dishonoured by the drawee on account of insufficiency of funds.
The criminal liability of a drawer in case of dishonour of cheque is dealt in section 138
to Section 142 of Negotiable Instrument Act 1881.
MAXIMUM PUNISHMENT
The maximum punishment for such an offence is imprisonment up to 2 years or fine up
to twice the amount of cheque or both.
Where the cheque is drawn by a company, a firm, or association of individuals, the
punishment can be awarded to every person who was in-charge of and was responsible
for its conduct of business and also to the company.
Add: A Chapter: Negotiation of Negotiable Instrument
 Negotiation by Delivery
 Negotiation by Endorsement and Delivery
CONCLUSION
After the amendment of 2002 and insertion of such penal provision has given relief to
the drawee. It has also helped in curtailing the dishonest intention of doing fraud. The
steps can be taken as remarkable steps in the banking sector.
 CHAPTER: 4
Holder and Holder in due Course Holder
The holder of a negotiable instrument means any person entitled to the possession of the
instrument in his own name and to receive or recover the amount due there on from the
parties liable thereto. Thus, in order to be called a ‘holder’ a person must satisfy the
following two conditions: (Sec. 8).
(1) He must be entitled to the possession of the instrument in his own Name. Actual
possession of the instrument is not essential. What is required is a right to possession
under some legal or valid title. He should be a ‘de jure holder’ and not necessarily ‘de
facto holder’. It means that the person must be named in the instrument as the payee or
the indorsee, or he must be the bearer thereof, if it is a bearer instrument. However, the
heir of a deceased holder or any other person becoming entitled by operation of law is a
holder although he is not the payee or indorsee or bearer thereof.
If a person is in possession of a negotiable instrument without having a right to possess
the same, he cannot be called the holder. Thus, a thief, or a finder on the road, or an
indorsee under a forged endorsement, although may be having the possession of the
instrument, cannot be called its holder because he does not acquire legal title thereto
and hence is not entitled in his own to the possession thereof. Similarly, a beneficial
owner claiming through a ‘benamidar’ in whose favour the instrument had been made
or drawn is not a holder because he is not entitled to the possession in his own name
and cannot by himself maintain an action on the instrument.
(2) He must be entitled to receive or recover the amount due there on from the parties
liable thereto. In order to be called a holder, besides being entitled to the possession of
the instrument in his own name, the person must also have the right to receive or
recover the amount of the instrument and give a valid discharge to the payer. Thus, one
may be the bearer or the payee or the indorsee of an instrument but he may not be called
a holder if he is prohibited by a Court order from receiving the amount due on the
instrument.
Where a person obtains possession of an instrument by theft, fraud or under a forged
endorsement, he is not a holder and can not a holder and cannot claim payment from
liable parties.
Holder in due Course
The despotic but necessary principle relating to negotiable instruments is that a person
taking a negotiable instrument in good faith and for value obtains a valid title though he
takes from one who had none or who was merely a thief. The property in a negotiable
instrument is acquired by anyone who takes it bona-fide and for value, notwithstanding
any defect of title in the person from whom he took it. Now such a person who takes an
instrument “in good faith and for value” becomes the true owner of the instrument and
is known as a “holder in due course”.
According to Section 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 endorsee 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 essential qualifications of a “holder in due course” may be summed up as follows:
1. He must be a holder for valuable consideration. All the prerequisite of consideration
should be met so as to result in a valuable consideration.
2. That he became the holder of the instrument before its maturity. Thus the person
who takes a negotiable instrument after maturity does not become a holder in due
course.
3. That the instrument should be complete and regular on the fact of it. Face here
includes the back also.
4. The last requirement is that the holder should have received the instrument in “good
faith”. There are two methods of ascertaining a person’s good faith, “subjective” and
objective”. In subjective test the Court has to see the holder’s own mind and the only
question is “did he take the instrument honestly”? In objective test, on the other
hand, we have to go beyond the holder’s mind and see whether he exercised as much
care in taking the security as a reasonably careful person ought to have done.
Subjective test requires “honesty”, objective “due care and caution”. Good faith
indicates a person takes the instrument without sufficient cause to believe that any
defect existed in the title of the person from whom he derived his title.
Right of a holder in due course
1. Once a negotiable instrument passes through the hands of a holder in due course, it
get cleansed of all defects, unless he himself was a party to fraud or illegality
committed regarding the instrument (S. 53).
2. The maker of a note or drawer of a bill or cheque, and no accepts of a bill for the
honour of the drawer, will be permitted to deny the validity of the instrument, as
originally drawn, in a suit thereon by a holder in due course.
3. In case of a suit by holder in due course, no maker of a note, or acceptor of a bill
payable to order, will be permitted to deny the validity of the payee’s capacity at the
date of the note of a bill to endorse the same (S.121).
4. Upon a suit by a holder in due course the acceptor cannot take the defence or
accommodation acceptance (S. 36).
5. The holder in due course gets a better title than that of the transferor of the
instrument, even if the title of the transferor was defective, the holder in due course
will get a good title. But in case of a forged instrument, even a holder in due course
will get no title, as it is a case of total absence of title and not a mere defect of title
(S. 58).
6. If a note or a bill is negotiated to a holder in due course the liable parties cannot
avoid liability on the ground, that delivery of the instrument was conditional or for a
special purpose (S. 46, 47).
7. When a bill is drawn payable to the drawer’s order on a fictitious name, and is
endorsed by the same hand as drawer’s signature, the acceptor cannot take the plea
that the payee was a fictitious person (S. 42).
8. Where a duly stamped and signed instrument is either left wholly blank or in
complete in some material requirements such as date, amount, payee’s name, and is
delivered by one person to another for the purpose of filling it up.
If such a person or any holder fills up more amount, than what he was authorized to
do. The holder in due course of such an instrument can recover the whole amount,
provided the stamp affixed upon it is sufficient to cover the filled sum (S.20).

Differences between Holder & Holder-In-Due-Course

Various differences between holder and holder-in-due-course can be explained on the
basis of the following
 Entitlement
 Maturity
 Right to recover amount
 Privileges
 Consideration
 Title
 Notice of defect in the Title
1.Entitlement: Holder is a person who is entitled for the possession of a negotiable
instrument in his own name. Hence, he shall receive or recover the amount due thereon.
Whereas a Holder-in-due-course is a person who has obtained the instrument for
consideration and in good faith and before maturity.
2.Consideration: Consideration is not necessary to become a holder. The instrument
may also be given by way of a donation or gift and thus, the donee of an instrument can
also become a holder of it. However, consideration is a must to become a holder-in-due-
course and thereby the donee of a negotiable instrument can be a holder but not holder-
in-due-course.
3.Maturity: A holder may acquire the instrument even after its maturity. But a holder-
in-due-course must acquire the instrument before its maturity failing which he will not
enjoy the rights of a holder-in-due-course.
4.Title: A holder does not acquire a better title than that of transferor. In simple words,
if the title of any of the prior party is defective, his title will not be defect free. Whereas,
a holder-in-due-course derives a good title freed from all defects. His title is better than
that of the transferor.
5.Right to recover amount: A holder has a right to recover the amount due on the
instrument from the transferor (i.e., just preceding party) only from whom he has
obtained the instrument. Holder-in-due-course, on the other hand, can recover the
amount due on the instrument from any of the prior parties till the instrument is duly
discharged. Thus, all prior parties shall remain liable towards the holder-in-due-course,
jointly as well as severally, till the instrument is duly discharged.
6.Notice of defect in the Title: A holder-in-due-course is not only supposed to have
acquired the instrument without any notice of the defect of the title of the person from
whom he obtained it, but also there should be no cause on his part to believe that any
defect sustains in the transferor’s title. But a holder is exempt from this condition. He
may have notice of defect in the title but he shall not be liable for it unless he is a party
to that defect, fraud, or forgery.
7.Privileges: A holder-in-due-course enjoys certain privileges under the Negotiable
instruments Act (as discussed earlier), which are not available to a holder.

Summary of the Unit

Negotiable’ means ‘transferable by delivery’ and the word ‘instrument’ means ‘a
written document by which a right is created in favour of some person’
Thus the term ‘Negotiable Instrument’ literally means ‘a written document transferable
by delivery’
According to Sec. 13 of the Act, negotiable instrument means ‘a Promissory Note, Bills
of Exchange or Cheque payable either to order or to bearer’.
The instruments should follow the given condition of negotiability that are;
 Easy negotiability.
 Transferee can sue in his own name without giving notice to the debtor.
 Better title to a bona fide transferee for value.

Different kinds of negotiable instruments

 Negotiable Instruments by Statue: Promissory note, Bills of exchange and Cheque.
 Negotiable Instruments by Usage: Bank note, draft, Share warrants, Bearers,
Debentures, Dividend warrants and Treasury bill.
1. Promissory Note- According to sec. 4 of the Act a promissory note is an instrument
in writing (not being a bank or a currency note) containing an unconditional
undertaking, signed by the maker to pay a certain sum of money to, or to the order
of, a certain person or to the bearer of the instrument.
2. Bills of Exchange- According to sec. 5 of the Act 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.
 Cheque - According to sec. 6 of the Act a cheque is an order by the customer of the
bank directing his banker to pay on demand, the specified amount, to or to the order
of the person named therein or to the bearer.

Self-assessment questions
Negotiable Instruments Act with Answers:
1. A promissory note, bill of exchange or cheque payable either to order or to bearer is
called – NegotiableInstrument
2. How many total sections are there in the Negotiable Instruments Act?– 147
3. Which section of Negotiable Instruments Act deals with Promissory Note?–
Section4
4. In which section bill of exchange is dealt with in Negotiable Instruments Act?–
Section5
5. What does Section 6 deals with in Negotiable Instruments Act?– Cheque
6. Which section in Negotiable Instruments Act deals with Negotiable Instruments?–
Section13
7. Drawee is defined in which section of Negotiable Instruments Act?– Section 7
8. Which section of Negotiable Instruments Act deals with Dishonour by non-
payment?– Section92
9. Which section of Negotiable Instruments Act deals with Cheque crossed generally?
– Section123
10.Which section of Negotiable Instruments Act deals with Presumptions as to
Negotiable Instruments?– Section118
11.Which section of Negotiable Instruments Act deals with Dishonouring of Cheque?–
Section 138
12.What type of negotiable instrument is a currency note?– Money is Not a Negotiable
Instrument
13.An order in writing directing a person to pay a sum of money to a specified person is
called _____. – BillofExchange
14.A bill of exchange drawn on a specified banker, and not expressed to be payable
otherwise than on demand is called ____. – Cheque
15.How many type of cheques are there as per the Negotiable Instruments Act?– 4
(Open cheque, Crossed cheque, Bearer cheque, Order cheque)

Review Questions
Define just in a sentence.
 Negotiable Instrument
 Holder in due course
 Cheque
 Double Crossing
 3Promissory Note
 Due Date of a Bill or Note
 Bill of Exchange
 Negotiable by Statute
 Holder
 Negotiable by usage or trade

Space for notes

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