Recording Date: Intermediate (IPC) Course Paper 2 - Business Laws Ethics and Communication Chapter 2 : The Negotiable Instruments Act, 1881 Mr. R.K. Khurana The Institute of Chartered Accountants of India
The Negotiable Instruments Act, 1881 Importance from Real Life & Examination Perspectives
This Lesson covers: 1. Meaning of Negotiable Instruments 2. Important Characteristics of Negotiable Instruments 3. Various Negotiable Instruments - Promissory Notes, Bills of Exchange, Cheques 4. Classification of Negotiable Instruments 5. Negotiation and Assignment 6. Presentment and Dishonour of Negotiable Instrument 7. Lesson Sum up 3
Definition of Negotiable Instrument A negotiable instrument may be defined as an instrument, the property in which 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. An instrument cannot be negotiable, unless it is in such a state that the true owner could transfer the contract or engagement contained therein by simple delivery of instrument Willis The Law of Negotiable Securities, 4
Conditions of Negotiability According to this definition, the following are the conditions of negotiability: (i) The instrument should be freely transferable. An instrument cannot be negotiable unless it is such that the true owner could transfer by : (a) Simple delivery or (b) Endorsement and delivery. (ii) The person who takes it for value and in good faith, is not affected by the defect in the title of the transferor. (iii) Such a person can sue upon the instrument in his own name. 5
Important Characteristics of Negotiable Instruments are: 1. Written Instrument with signature 2. Negotiable Instruments made or drawn for consideration 3. Transfer/ negotiation by endorsement or by endorsement and delivery 6
Important Characteristics of Negotiable Instruments are: 4. Bonafide and for valuable consideration - entitles good title for transferee 5. The holder of the Negotiable Instrument is presumed to be the owner of the property contained in it. 6. Certain presumptions are applicable to all negotiable instruments unless the contrary is proved 7. These presumptions are: Date, time of acceptance, time for transfer, order or endorsements, stamp. These presumptions are rebuttable only on evidence 7
Important Characteristics of Negotiable Instruments are: 8. The NIs are freely transferable. 9. A holder in due course gets the instrument free from all defects of title of any previous holder. 10. The holder in due course is entitled to sue on the instrument in his own name. 11. The instrument is transferable till maturity and in case of cheque, till it becomes stale (on expiry of 6 months from the date of issue.) 8
Types of Negotiable Instruments The N.I. May be: Negotiable by statues Negotiable by custom or usage 9
Negotiable Instruments under the N.I. Act, 1881 The N.I. Act has not defined the term. It merely says that A negotiable instrument means a: i. Promissory Note, ii. Bill of exchange or iii. Cheque payable either to order or to bearer. [Section 13(1)] 10
1. Promissory Note A promissory note is an instrument in writing (not being a bank note or a currency note), containing an unconditional undertaking, signed by the maker to pay a certain sum of money to, or to the order of, a certain person, or only to bearer of the instrument. (Section 4) 11
Parties to a Promissory Note are: 1. The Maker: the person who makes or executes the note promising to pay the amount stated therein. 2. The Payee: one to whom the note is payable. 3. The Holder: is either the payee or some other person to whom he may have endorsed the note. 4. The Endorser. 5. The Endorsee 12
Essentials of a Promissory Note: To be a promissory note, an instrument must possess the following essentials: (a) It must be in writing. An oral promise to pay will not do. (b) It must contain an express promise or clear undertaking to pay. A promise to pay cannot be inferred. Illustration: A mere acknowledgement of debt is not sufficient. If A writes to B I owe you (I.O.U.) Rs. 500, there is no promise to pay and the instrument is not a promissory note. (c) The promise or undertaking to pay must be unconditional. A promise to pay when able, or as soon as possible, or after your marriage to D, is conditional. But a promise to pay after a specific time or on the happening of an event which must happen, is not conditional, e.g. I promise to pay Rs. 1,000 ten days after the death of B, is unconditional. (d) The maker must sign the promissory note in token of an undertaking to pay to the payee or his order. 13
Essentials of a Promissory Note: To be a promissory note, an instrument must possess the following essentials: (e) The maker must be a certain person, i.e., the note must show, clearly who is the person engaging himself to pay. (f) The payee must be certain. The promissory note must contain a promise to pay to some person or persons ascertained by name or designation or to their order. (g) The sum payable must be certain and the amount must not be capable of contingent additions or subtractions. If A promises to pay Rs. 100 and all other sums which shall become due to him, the instrument is not a promissory note. (h) Payment must be in legal money of the country. Thus, a promise to pay Rs. 500 and deliver 10 quintals of rice is not a promissory note. 14
Essentials of a Promissory Note: To be a promissory note, an instrument must possess the following essentials: (i) It must be properly stamped in accordance with the provisions of the Indian Stamp Act, 1899. Each stamp must be duly cancelled by maker s signature or initials. (j) It must contain the name of place, number and the date on which it is made. However, their omission will not render the instrument invalid, e.g. if it is undated, it is deemed to be dated on the date of delivery. Note : As per Section 31 of the RBI Act, 1934, a promissory note cannot be made payable or issued to bearer, no matter whether it is payable on demand or after a certain time. 15
2. Bill of Exchange 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. (Section 5) The definition of a bill of exchange is very similar to that of a promissory note and for most of the cases, the rules which apply to promissory notes are in general applicable to bill of exchange. There are however, certain important points of distinction between the two. 16
Parties to the Bill of Exchange are: 1. The Drawer: The person who draws the bill. 2. The Drawee: The person on whom the bill is drawn. 3. The Acceptor: One who accepts the bill. Generally, the drawee is the acceptor but a stranger may accept it on behalf of the drawee. 4. The Payee: One to whom the sum stated in the bill is payable, either the drawer or any other person may be the payee. 5. The Holder: Is either the original payee or any other person to whom, the payee has endorsed the bill. In case of a bearer bill, the bearer is the holder. 6. The Endorser: When the holder endorses the bill to any one else he becomes the endorser 7. The Endorsee: Is the person to whom the bill is endorsed. 17
Parties to the Bill of Exchange are: 8. The Drawee in case of need: Besides the above parties, another person called the drawee in case of need, may be introduced at the option of the drawer. Who may introduce drawee in need: The name of such a person may be inserted either by the drawer or by any endorser in order that resort may be had to him in 9. Acceptor for Honour 18
Essentials of Bill of Exchange 1. It must be in writing 2. It must contain an unconditional order to pay money only 3. It must be signed by the drawer. 4. The parties must be certain. 5. The sum payable must also be certain 6. It must comply with other formalities e.g. stamps, date, etc. 7. The Endorsee: Is the person to whom the bill is endorsed. 19
Distinction between Bill of Exchange and Promissory Note 1. Number of parties 2. Nature of promise i.e. Unconditional promise to pay or order to pay 3. Nature of debt i.e. In case of note the maker the Principal Debtor in case of B/E surety 4. Nature of liability 5. A note cannot be made payable to the maker himself; a B/E can be made payable to the drawer himself. 6. Note requires no acceptance, the B/E requires acceptance 7. Certain provisions like (a) presentment for acceptance, acceptance for honour do not apply in case of note. 8. In case of dishonour of B/E, due notice is required to be sent to all prior parties, including drawer. No such notice is required in case of P. Note to the maker. 20
3. Cheque Section 6 of the Act provides that 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. The Negotiable Instruments (Amendment and Miscellaneous Provisions) Act, 2002 has broadened, the definition of cheque to include the electronic image of a truncated cheque and a cheque in the electronic form. 21
Parties to a cheque Essentials of a cheque Distinction between cheques and Bills of Exchange Specimen of a cheque: XYZ Bank Limited Pay A or the bearer a sum of Rupees Dated Rs. No. Sd/ 22
Crossing of Cheque 1. The usuage of crossing of cheques 2. Special Crossing 3. Crossing after issue 4. Payment of cheques crossed generally or specially 5. Payment in due course of crossed cheque 6. Payment out of due course 7. Cheques marked Not negotiable 8. Cheques marked Account Payee 9. Protection in respect of cheques unmarked cheques 23
4. Classification of Negotiable Instruments: 1. Bearer Instruments 2. Order Instruments 3. Inland Instruments 4. Foreign Instruments 5. Demand Instruments 24
Classification of Negotiable Instruments: 6. Time Instruments 7. Ambiguous Instruments 8. Inchoate or Incomplete Instruments 25
5. Maturity and days of grace 6. Payment in due course 7. Ambiguous Instruments 8. Inchoate or Incomplete Instruments 26
Parties to Negotiable Instruments 1. Capacity of parties: Capacity to enter into contract. 2. Position of minors under N. Instruments 3. Position of Company/Body Corporate 4. Position of partners 27
Parties to Negotiable Instruments 1. Parties to B/E: (a) Drawer, (b) drawee (c ) Acceptor, (d) Payee, holder (e) holder in due course (f) endorser, (g) endorsee, (h) drawee in case of need, (i) acceptor for honour 2. Parties to Promissory Note 3. Parties to cheque 28
Negotiation and Assignment Transfer of N.I. By Negotiation By assignment Negotiation by By endorsement delivery and delivery 29
Distinction between negotiation and assignment The N.I. 1881 Act does not deal with transfer of NI by assignment S N Negotiation Assignment 1. Consideration is presumed Not presumed, must be proved 2. Title of holder transferee (H in due course better 3. Notice of transfer of NI to debtor by transferer not necessary 4. Transfer possible by delivery or by endorsement and delivery Title subject to defect of the right of transferer Notice necessary Must be in writing 30
Endorsement In its literal sense, the term endorsement means writing on an instrument. In technical sense, in NI Act, it means writing of a person s name (otherwise than as maker) for the purpose of negotiation 31
Essentials of valid endorsement Who may endorse: First endorsement by Payee, subsequent endorsements by holders Essential of valid endorsement 1. Must be on the instrument itself or on additional sheet called allonge 2. Signed by endorser 3. Complete endorsement or endorsement inblank 4. Must be completed by delivery of instrument 32
Kinds of endorsements 1. Endorsement in blank or general endorsement 2. Full or special endorsement 3. Restrictive endorsement 4. Partial endorsement 5. Conditional endorsement 6. Negotiation back 33
Holder and Holder in due course 1. Holder According to Section 8 of the Act a person is a holder of a negotiable instrument who is entitled in his own name (i) to the possession of the instrument, and (ii) to recover or receive its amount from the parties thereto. 2. It is not every person in possession of the instrument who is called a holder. 3. To be a holder, the person must be named in the instrument as the payee, or the endorsee, or he must be the bearer thereof. 4. A person who has obtained possession of an instrument by theft, or under a forged endorsement, is not a holder, as he is not entitled to recover the instrument. The holder implies de jure (holder in law) holder and not de facto (holder in fact) holder. An agent holding an instrument for his principal is not a holder although he may receive its payment. 34
Holder and Holder in due course Holder in due course: Section 9 states that a holder in due course is (i) (ii) a person who for consideration, obtains possession of a negotiable instrument if payable to bearer, or the payee or endorsee thereof, if payable to order, before its maturity and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title. 35
In order to be holder in due course, a person must satisfy the following conditions: 1. He must be a holder of the instrument 2. He should have obtained the instrument for value or consideration. 3. He must have obtained the negotiable instrument before maturity. 4. The instrument should be complete and regular on the face of it. 5. The holder should take the instrument in good faith. 36
A holder in due course is in a privileged position He is not only himself protected against all defects of the persons from whom he received the instrument as current coin, but also serves as a channel to protect all subsequent holders. A holder in due course can recover the amount of the instrument from all previous parties, although, as a matter of fact, no consideration was paid by some of the previous parties to the instrument or there was a defect of title in the party from whom he took it. Once an instrument passes through the hands of a holder in due course, it is purged of all defects 37
Liabilities of parties to Negotiable Instruments 1. Liabilities of a drawer (Sec 30) 2. Liability of the Drawee of Cheque (Sec 31) 3. Liability of the Maker of Note and Acceptor of Bill (Sec 32) 4. Liability of Endorser (Sec 35) 5. The liability of prior parties. 38
Liabilities of parties to Negotiable Instruments 6. Liability inter se 8. Acceptor s Liability on a bill drawn in a Fictitious Name 39
Negotiation and Assignment of Negotiable Instruments A negotiable instrument may be transferred by negotiation or assignment. Negotiation is the transfer of an instrument (a note, bill or cheque) by one person to another in such a manner as to convey title and to constitute the transferee the holder thereof. When a negotiable instrument is transferred by negotiation, the rights of the transferee may rise higher than those of the transferor, depending upon the circumstances 40
Negotiation and Assignment of Negotiable Instruments In case of assignment, there is a transfer of ownership by means of a written and registered document. When the transfer is made by assignment, the assignee has only those rights which the assignor possessed. 41
Distinction between Negotiation and assignment (i) Negotiation requires mere delivery of a bearer instrument and endorsement and delivery of an order instrument to effectuate a transfer. Assignment requires a written document signed by the transferor. (ii) Notice of transfer of debt (actionable claim) must be given by the assignee to the debtor in order to complete his title; No such notice is necessary in a transfer by negotiation. (iii) On assignment, the transferee of an actionable claim takes it subject to all the defects in the title of, and subject to all the equities and defences available against the assignor, even though he took the assignment for value and in good faith. In case of negotiation the transferee, as holder-in-due course, takes the instrument free from any defects in the title of the transferor 42
Presentment of N. Instrument Presentment means showing an instrument to the drawee, acceptor or maker for acceptance, sight or payment Three types of presentment: (i) Of B/E for acceptance (ii) Of Promissory note for site (iii) Presentment of NI for Payment Presentment for acceptance and presentment for payment Presentment when excused 43
Essentials of a valid for acceptance 1. It must be written on the bill 2. It must be signed by the drawee personally or his duly authorised agent. 3. Accepted bill must be delivered to the holder 44
Presentment of N. Instrument Presentment means showing an instrument to the drawee, acceptor or maker for acceptance, sight or payment Presentment of Instrument Presentment for acceptance and presentment for payment Presentment when excused 45
Dishonour of Negotiable Instruments Dishonour for non-acceptance Dishonour for non-payment Notice of dishonour Notice of dishonour - when not necessary? If a nominee predeceases the employee, the interest of the nominee shall revert to the employee who shall make a fresh nomination,. 46
Discharge of Negotiable Instruments 1. By payment in due course 2. When the principal debtor becomes the holder 3. By an act that would discharge simple contract 4. By renunciation 5. By cancellation 47
Banker Customer Relationship A banker is one who does banking business. Section 5(b) of the Banking Regulation Act, 1949 defines banking as, accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft or otherwise. This definition emphasises two points: (1) The primary function of a banker consists of accepting of deposits for the purpose of lending or investing the same; (2) The amount deposited is repayable to the depositor on demand or according to the agreement. The demand for repayment can be made through a cheque, draft or otherwise, and not merely by verbal order. 48
Customer The term customer is neither defined in Indian nor in English statutes. The general opinion is that a customer is one who has an account with the bank or who utilises the services of the bank. The special features of the legal relationship between the banker and the customer may be termed as the obligations and rights of the banker. These are: 1. Obligation to honour cheques of the customers. 2. Obligation to collect cheques and drafts on behalf of the customers. 3. Obligation to keep proper record of transactions with the customer. 4. Obligation to comply with the express standing instructions of the customer. 5. Obligation not to disclose the state of customer s account to anyone else. 49
Banker s obligations and rights against Customer 6. Obligation to give reasonable notice to the customer, if the banker wishes to close the account. Rights of Banker 7. Right of lien over any goods and securities bailed to him for a general balance of account. 8. Right of set off and right of appropriation. 9. Right to claim incidental charges and interest as per rules and regulations of the bank, as communicated to the customer at the time of opening the account. 50
Liability of a Banker When Banker must refuse payment 1. When a customer countermands payment,i.e., where or when a customer, after issuing a cheque issues instructions not to honour it, the banker must not pay it. 2. When the banker receives notice of customer s death. 3. When customer has been adjudged an insolvent. 4. When the banker receives notice of customer s insanity. 5. When an order (e.g., Garnishee Order) of the Court, prohibits payment. 51
Liability of a Banker When Banker must refuse payment 6. When the customer has given notice of assignment of the credit balance of his account. 7. When the holder s title is defective and the banker comes to know of it. 8. When the customer has given notice for closing his account. 52
Liability of a Banker When Banker may refuse payment 1. When the cheque is post-dated. 2. When the banker has no sufficient funds of the drawer with him and there is no communication between the bank and the customer to honour the cheque. 3. When the cheque is of doubtful legality. 4. When the cheque is not duly presented, e.g., it is presented after banking hours. 5. When the cheque on the face of it is irregular, ambiguous or otherwise materially altered. 53
Liability of a Banker When Banker may refuse payment 6. When the cheque is presented at a branch where the customer has no account. 7. When some persons have joint account and the cheque is not signed jointly by all or by the survivors of them. 8 When the cheque has been allowed to become stale, i.e., it has not been presented within six months of the date mentioned on it. 54
Protection to Paying Banker Payment in due course The payment will be a payment in due course if: 1. it is in accordance with the apparent tenor of the instrument, i.e., according to what appears on the face of the instrument to be the intention of the parties; 2. it is made in good faith and without negligence, and under circumstances which do not afford a ground for believing that the person to whom it is made is not entitled to receive the amount; 55
Protection to Paying Banker Payment in due course: The payment will be in due course if: 3. it is made to the person in possession of the instrument who is entitled as holder to receive payment; 4. payment is made under circumstances which do not afford a reasonable ground believing that he is not entitled to receive payment of the amount mentioned in the instrument; and 5. payment is made in money and money only. 56
Collecting Banker Collecting Banker is one, who collects proceeds of a cheque for a customer. Section 126 of the Act provides that a i. cheque bearing a general crossing shall not be paid to anyone other than banker and ii. cheque which is specially crossed shall not be paid to a person other than the banker to whom it is crossed. 57
Lesson Summary Friends: I have attempted to place before you, the importance of Negotiable Instruments in the trade and commerce Types of Negotiable Instruments under the N.I. Act, 2017 Parties to N.I. and their rights and obligations Banker and Customer relationship Negotiation and assignment of N.I. Discharge of N.I. For more details, please refer to the ICAI Study Material and the Bare Act. 58
Thank You 59