Unit 4 — Exam Guide

Introduction

In the business world, negotiable instruments are important instruments of credit. A negotiable instrument is a transferable document that passes freely from one hand to another. In India, transactions relating to negotiable instruments are governed by the Negotiable Instruments Act, 1881. These instruments have significantly replaced actual cash in commercial dealings and greatly reduced the risks associated with handling cash.

Definition of Negotiable Instrument

Section 13 of the NI Act defines a negotiable instrument as "a promissory note, bill of exchange or cheque payable either to order or bearer." According to Justice K.C. Willis, a negotiable instrument is one whose property is acquired by anyone who takes it bonafide, and for value, notwithstanding any defect of title in the person from whom he took it.

Characteristic Features

• Transferability: A negotiable instrument must be transferable — bearer instruments by delivery, order instruments by endorsement and delivery
• Good Title to HDC: A bonafide transferee for value acquires absolute title even if the transferor had no title or a defective title
• Right to sue in own name: A holder in due course can sue on the instrument in his own name
• Consideration presumed: Under Section 118, consideration is presumed unless the contrary is proved
• Payable to Order/Bearer: Order instruments require endorsement; bearer instruments pass by mere delivery

Kinds of Negotiable Instruments

1. Promissory Note (Section 4)

A promissory note is an instrument in writing (not being a bank-note or currency-note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument.

Essentials: (a) Must be in writing; (b) Must contain express promise to pay; (c) Promise must be unconditional; (d) Signed by the maker; (e) Parties must be certain — maker and payee; (f) Sum must be certain.

2. Bill of Exchange (Section 5)

A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money to or to the order of a certain person or to the bearer.

Parties: (a) Drawer — person who draws the bill; (b) Drawee — person directed to pay; (c) Payee — person to whom payment is made; (d) Acceptor — person who accepts the bill; (e) Endorser and Endorsee — in case of transfer.

3. Cheque (Section 6)

A cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. It includes the electronic image of a truncated cheque and a cheque in electronic form.

Types: Bearer cheque, Order cheque, Open cheque, Crossed cheque, Anti-dated cheque, Post-dated cheque, and Stale cheque (presented after 3 months).

Distinctions

Cheque vs Promissory Note

• Cheque is an order to bank; PN is a promise by maker
• Cheque has 3 parties (drawer, drawee bank, payee); PN has 2 (maker, payee)
• Cheque is always payable on demand; PN may be payable after specified time
• No grace period for cheque; 3 days grace for PN payable after time
• No stamp required for cheque; stamp required for PN
• Cheque can be crossed; PN cannot

Cheque vs Bill of Exchange

• Cheque is drawn on specified banker only; BoE on any person or bank
• Cheque is always on demand; BoE may be payable on demand or after sight
• Cheque needs no acceptance; BoE requires acceptance
• Cheque can be crossed; BoE cannot
• Cheque valid for 3 months; BoE has no such restriction
• If dishonoured, cheque cannot be noted or protested; BoE can

Negotiable Instruments vs Transferable Instruments (Assignment)

• Negotiation is governed by the NI Act; assignment by the Transfer of Property Act
• In negotiation, the holder in due course gets a better title than the transferor; in assignment, the assignee cannot get better title than the assignor
• No notice of transfer required in negotiation; notice must be given to debtor in assignment
• Consideration is presumed in negotiation; must be proved in assignment
• Negotiation by mere delivery or endorsement + delivery; assignment requires a written document
• Negotiation relates to PN, BoE, cheque; assignment to other documents like insurance policies, supply bills, NSCs

Conclusion

Negotiable instruments occupy a prominent position in modern commercial life. The NI Act, 1881 provides a comprehensive framework governing their creation, transfer, and enforcement. The key distinction from mere transferable instruments lies in the superior title conferred upon a holder in due course, which promotes confidence and facilitates commerce.

Definition of Cheque

Section 6 of the Negotiable Instruments Act, 1881 defines a cheque as "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."

Types of Cheques

• Bearer Cheque: Payable to the person presenting it — "or bearer" words not cancelled
• Order Cheque: "bearer" cancelled, "or order" written — payable only to specified person or endorsee
• Open/Uncrossed Cheque: Payment obtainable at bank counter
• Crossed Cheque: Two parallel lines drawn across face — payment only through banking channels
• Anti-dated Cheque: Bears date earlier than presentation — valid for 3 months from date
• Post-dated Cheque: Bears future date — honoured only on or after due date
• Stale Cheque: Presented after 3 months from date — not honoured by bank

Crossing of Cheques

Crossing is an instruction given to the paying banker to pay the amount of the cheque through a banker only and not directly to the person presenting it at the counter. Sections 123 to 131 of the NI Act contain provisions relating to crossing. Under Section 131-A, these provisions also apply to bank drafts.

1. General Crossing (Section 123)

Where a cheque bears across its face an addition of the words "and company" or any abbreviation thereof, between two parallel transverse lines, or of two parallel transverse lines simply, either with or without the words "not negotiable", that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed generally.

Effect: The paying banker must not pay it otherwise than to a banker. Payment can be collected through any banker.

2. Special Crossing (Section 124)

Where a cheque bears across its face an addition of the name of a banker, either with or without the words "not negotiable", that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed specially, and to be crossed to that banker.

Effect (S.126): The paying banker must pay it only to the banker to whom it is crossed, or his agent for collection.

3. "Not Negotiable" Crossing (Section 130)

A person taking a cheque crossed generally or specially, bearing the words "not negotiable", shall not have, and shall not be capable of giving, a better title to the cheque than that which the person from whom he took it had. This does NOT mean the cheque is non-transferable. It is still transferable, but the transferee cannot get title better than what the transferor had. This effectively destroys the holder-in-due-course advantage.

4. "Account Payee" Crossing

The NI Act does not recognize "Account Payee" crossing, but it is prevalent as per banking practice in India. The RBI has directed banks that:

• Crediting proceeds of account payee cheques to parties other than the named payee is unauthorized
• Banks doing so act at their own risk and are responsible for unauthorized payment
• Banks indulging in deviation will invite severe penal action
• Relaxation for co-operative credit societies for cheques up to Rs. 50,000

5. Double Crossing

A specially crossed cheque cannot bear two special crossings — the very purpose of the first crossing is frustrated by the second. Exception: If the first banker submits the cheque to another banker as his agent for collection, the second crossing must specify it is acting as agent for the first banker.

Who Can Cross (Section 125)

• The drawer can cross the cheque at the time of drawing or thereafter
• The holder can cross an uncrossed cheque, or convert a general crossing into special
• The collecting banker can add his own name to a general crossing
• Only the drawer can open (cancel) a crossing

Conclusion

Crossing is a vital safety mechanism that ensures cheque payments flow through proper banking channels, reducing the risk of fraud and unauthorized encashment. The combination of statutory provisions (S.123-131) and RBI directives (Account Payee) provides comprehensive protection to drawers and payees alike.

Definition of Endorsement

Section 15 of the Negotiable Instruments Act, 1881 defines endorsement as follows: "When 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, or so signs for the same purpose a stamped paper intended to be completed as a negotiable instrument, he is said to have endorsed the same and is called the endorser."

The person who signs is the endorser and the person in whose favour the instrument is transferred is the endorsee. Endorsements are usually made on the back of the instrument; if insufficient space, a slip of paper called an allonge may be attached.

Effect of Endorsement (Section 50)

The endorsement of a negotiable instrument followed by delivery transfers the endorsed property therein with the right of further negotiation. The endorsee acquires property in the instrument as its holder and can negotiate it further (unless restricted). Section 50 also permits endorsement to constitute the endorsee an agent of the endorser — to endorse further or to receive the amount for the endorser.

Legal Provisions Regarding Endorsements

• Who may endorse (S.51): Every sole maker, drawer, payee or endorsee — in case of joint holders, all must endorse
• Time (S.60): An instrument may be negotiated until payment at or after maturity, but not after
• Partial endorsement invalid (S.56): Must be for the entire amount; endorsement for part of the amount is void for negotiation
• Death of endorser (S.57): Legal representative of deceased endorser cannot negotiate by delivery alone if endorser died before delivery
• Presumption (S.118): Endorsements on an instrument are presumed to have been made in the order in which they appear

Kinds of Endorsement

(a) Endorsement in Blank / General Endorsement

An endorsement is said to be blank or general when the endorser puts his signature only on the instrument and does not write the name of anyone to whom or to whose order the payment is to be made. The effect is that the instrument becomes payable to bearer and can be further negotiated by mere delivery without any endorsement. Under Section 49, any holder may convert a blank endorsement into a full endorsement by writing above the endorser's signature a direction to pay to any person as endorsee.

(b) Endorsement in Full / Special Endorsement

An endorsement is special or in full if the endorser, in addition to his signature, also mentions the name of the person to whom or to whose order the payment is to be made. There is a direction added by the endorser to the specified person (the endorsee), who becomes the payee entitled to sue for the money. Example: "Pay to Ram or order — (signed) Shyam."

(c) Conditional Endorsement (Section 52)

A conditional endorsement is one where the endorser makes his liability or the right of the endorsee to receive the amount depend upon the happening of a specified event, although such event may never happen. The endorser may also exclude his own liability by express words.

Illustrations from the Act:

• (a) The endorser signs adding "without recourse" — incurs no liability
• (b) A endorses "without recourse" to B, B endorses to C, C endorses to A — A is reinstated in former rights and has rights of endorsee against B and C

(d) Restrictive Endorsement

A restrictive endorsement puts an end to the principal characteristic of a negotiable instrument and seals its further negotiability. The endorsee is within his rights to restrict subsequent transfer. This prevents the risk of unauthorized persons obtaining payment through fraud or forgery. Example: "Pay to X only."

(e) Endorsement Sans Recourse

Sans Recourse means "without recourse or reference." When property in a negotiable instrument is transferred sans recourse, the endorser negates his liability and excludes himself from responsibility to all subsequent endorsees. It is one of the commonest forms of qualified endorsement and virtually prohibits risk to the endorser.

(f) Facultative Endorsement

A facultative endorsement is one where the endorser waives some right to which he is entitled. For example, the endorsee is normally liable to give notice of dishonour to the endorser — failure to give notice absolves the endorser from liability. But a facultative endorser waives this right, meaning that failure to give notice of dishonour will not absolve him from liability.

General Rules Regarding Form of Endorsements

• Signature: Must be the endorser's own or by a duly authorized person; block letters not accepted
• Spelling: Name must be spelt as it appears on the cheque as payee/endorsee; mis-spelt name must be endorsed as it appears, then correct name may follow
• Initials: No addition or omission of initials (e.g., cheque to S.C. Gupta must not be endorsed as S. Gupta)
• Prefixes/Suffixes: Mr., Mrs., Shri, Dr., Major etc. must be excluded; endorser may add title after signature
• Joint holders: All must sign if cheque payable to two or more persons

Conclusion

Endorsement is the primary mechanism of transferring negotiable instruments under the NI Act. The six kinds of endorsement serve different commercial purposes — from simple transfer (blank and full) to risk management (sans recourse and conditional) to fraud prevention (restrictive). In Kunju Pillai v. Periasami, the High Court held that a holder who secures an instrument by endorsement does not lose his right of action by the death of the original payee, affirming the strength of endorsement as a mode of transfer.

The Paying Banker

The paying banker is the bank on which a cheque is drawn — the bank whose name is printed on the cheque — and which pays the amount and deducts the sum from the customer's account.

Payment in Due Course (Section 10)

Section 10 defines "payment in due course" as "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 reasonable ground for believing that he is not entitled to receive payment."

Precautions of the Paying Banker

1. Type of Cheque: If open — pay at counter; if crossed — pay only to a fellow banker
2. Branch: Cheque must be drawn on the branch where account is kept
3. Banking Hours: Must be presented during banking hours on a business day
4. Mutilation: Torn, cancelled or mutilated cheques must not be honoured
5. Printed Form: Customer should draw cheques only on printed leaves supplied by banker
6. Unconditional Order: Cheque should not contain any condition
7. Date: Anti-dated cheque honoured if within 3 months; post-dated honoured only on due date; stale cheque (beyond 3 months) refused
8. Amount: Words and figures must agree
9. Material Alteration: If alteration found, return with memo "Alteration requires drawer's confirmation" — under S.87, material alteration renders instrument void
10. Sufficient Balance: If insufficient funds, banker justified in returning cheque
11. Signature: Must match specimen signature of customer
12. Endorsement: Must verify regularity of endorsement
13. Legal Bar: Garnishee order, customer's death, insolvency, or unsoundness of mind — limits duty to pay

Statutory Protection to the Paying Banker

1. Protection for Order Cheque — S.85(1): "Where a cheque payable to order purports to be endorsed by or on behalf of the payee, the drawee is discharged by payment in due course." Two conditions: (a) endorsement must be regular; (b) payment must be made in due course.

2. Protection for Bearer Cheque — S.85(2): A cheque originally issued as bearer always remains bearer, irrespective of endorsements (full or blank) or any restriction on further negotiation. Banker need not verify regularity of endorsements. If payment made in due course to bearer of uncrossed bearer cheque — banker discharged even if cheque was stolen.

3. Protection for Crossed Cheque — S.128: Where the paying banker pays a crossed cheque in due course as per crossing instructions, both the banker and the drawer are entitled to the same rights as if the amount had been received by the true owner. Even if payment went to wrong person through collecting banker, paying banker is protected.

The Collecting Banker

The collecting banker undertakes the collection of cheques, drafts, bills of exchange, and dividend warrants for his customer.

Role of a Collecting Banker

1. Receives cheques from customer for collection
2. Segregates into local cheques (presented through clearing) and outstation cheques (sent by post)
3. Credits customer's account upon realization
4. If dishonoured — informs customer and returns with "R.D." (Refer to Drawer) remark

General Duties

• Collect only for his customer — not for strangers
• Insist on satisfactory introduction or reference before opening account
• Examine validity of customer's title to the cheque
• Examine correctness of all endorsements
• Get uncrossed cheques crossed by the customer before accepting for collection — never cross himself

Collecting Banker as Holder for Value

The collecting banker becomes a holder for value when he:

• Pays the value of a cheque to the customer before it is collected
• Acquires a cheque in exchange for cash
• Allows customer to withdraw money against uncleared cheque
• Exercises lien on the proceeds or appropriates proceeds towards customer's loan
• Advances money against the cheque meant for collection

Statutory Protection — Section 131

"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."

Conditions for protection:

1. Protection available only for a crossed cheque
2. Cheque must be crossed before reaching the collecting banker — if banker himself crosses it, no protection
3. Must have collected as agent for customer, not as holder for value
4. Must have acted in good faith and without negligence

Section 131-A extends this protection to collection of bank drafts with forged endorsement or defective title.

Conclusion

The NI Act provides a balanced framework of duties and protections for both paying and collecting bankers. The paying banker is protected under S.85 and S.128 provided he makes payment in due course after exercising proper precautions. The collecting banker enjoys protection under S.131 for crossed cheques collected in good faith and without negligence. These protections promote confidence in the banking system while holding bankers accountable for negligence.

Introduction

Cheque is one of the chief forms of negotiable instrument and a common way of settling accounts in commercial transactions. Earlier, only Section 420 IPC was available for criminal liability where mens rea had to be proved. To combat the growing trend of issuing cheques without sufficient funds, Section 138 was inserted by the Negotiable Instruments (Amendment) Act, 1988 to make the drawer liable for penalties in case of bouncing of cheques.

Concept of Dishonour

When a cheque issued by the drawer is not paid by the paying banker on presentation, it is said to be dishonoured. Under Section 31, whenever a customer demands or issues a cheque, the banker is obligated to honour it. If the banker dishonours without sufficient reason, he is liable to compensate the drawer for any loss or damage.

Circumstances Where Banker's Refusal is Justified

• Insufficiency of funds or exceeding arrangement
• Customer countermands payment (stop payment)
• Post-dated cheque presented before due date; stale cheque (3 months expired)
• Mutilated cheque or signature mismatch
• Death, insolvency, or unsoundness of mind of customer
• Garnishee order, attachment under Income Tax
• Forgery, doubtful legality, closure of account

Section 138 — The Offence

Section 138 provides that if any customer draws a cheque for discharge of any debt or other liability and it is returned unpaid due to insufficient balance or exceeding the amount available, he shall be punishable. Mens rea is irrelevant and need not be proved.

Essential Conditions (Ingredients of the Offence)

1. Cheque should have been issued in discharge of a debt or other legal liability
2. Cheque presented within 3 months from the date of drawing (validity period)
3. Cheque returned unpaid due to insufficiency of funds or exceeding arrangement — bank issues a "Cheque Return Memo"
4. Payee or holder in due course sends written notice within 30 days of receiving information of dishonour, demanding payment
5. Drawer fails to make payment within 15 days of receipt of notice
6. Complaint filed within 1 month from expiry of 15-day period, before Metropolitan Magistrate or Judicial Magistrate First Class (S.142)

Punishment

Imprisonment for a term up to 2 years, or fine which may extend to twice the amount of the cheque, or both.

Other Provisions

• S.141 — Offence by Companies: Every person who was in charge of and responsible for conduct of business is deemed guilty — defense: offence committed without knowledge or due diligence exercised. Government-nominated directors exempted.
• S.142 — Cognizance: Complaint in writing by payee/HDC within 1 month. Court may condone delay if sufficient cause shown. Banker's memo accepted as prima facie evidence.
• S.143: Trial to be conducted summarily on day-to-day basis, concluded within 6 months.
• S.147: Every offence under NI Act is compoundable.

Judicial Approach

In Electronics Trade & Technology Corp. v. Indian Technologies, the Supreme Court observed that the object of S.138 is to inculcate faith in banking operations and credibility in negotiable instrument transactions.

In MSR Leathers v. S. Palaniappan, the Supreme Court reversed its earlier judgment in Sadanandan Bhadran and held that a payee can issue a statutory notice upon each subsequent dishonour and institute proceedings on the basis of a second or successive notice.

In Dashrath Rupsingh Rathod v. State of Maharashtra, the Supreme Court ruled that S.138 cases must be initiated at the place where the drawee bank branch is located. The 2015 Amendment Act (inserting S.142 and S.142A) clarified jurisdiction with retrospective effect.

Noting and Protest

Noting (Section 99)

When a promissory note or bill of exchange has been dishonoured by non-acceptance or non-payment, the holder may cause such dishonour to be noted by a Notary Public upon the instrument or upon a paper attached thereto. The note must be made within a reasonable time after dishonour and must specify:

1. The date of dishonour
2. The reason for dishonour (if expressly dishonoured) or reason why holder treats it as dishonoured
3. The Notary's charges

The Notary Public re-presents the instrument to the defaulting parties. If acceptance or payment is still refused, the noting is recorded.

Protest (Section 100)

Protest is a more formal process following noting. It is a formal certificate issued with the Notary's seal attesting that the bill is dishonoured. The protest must contain:

1. Transcript of the instrument or the instrument itself
2. Names of persons against whom protested
3. Statement that acceptance/payment/better security was demanded and the response
4. Place and time of dishonour and place and time of refusal
5. Signature of the Notary

Noting and Protest is compulsory for foreign bills but optional for inland bills. Cheques cannot be noted or protested.

Material Alteration (Section 87)

Any material alteration of a negotiable instrument renders it void against anyone who was a party at the time of alteration and did not consent — unless made to carry out the common intention of original parties. In Veera Exports v. T. Kalavathy, the Supreme Court held that a drawer can voluntarily re-validate a cheque by altering dates. In Ramchandran v. K. Dineshan, the Kerala High Court held that any change altering the legal identity or business character of the instrument is material alteration, destroying the instrument's identity.

Conclusion

Section 138 is a vital provision ensuring credibility of cheques in commercial transactions. The strict procedure (3-30-15-1 timeline) balances the interests of payees and drawers. Noting and protest serve as proactive measures to protect holders' rights of recourse, while S.87 safeguards the integrity of negotiable instruments against unauthorized alterations.