Certificate in Accounting and Finance Business Law

C H

A P

T E

R

18

Negotiable Instruments Act

Contents

1 Meaning and characteristics of negotiable instruments 2 Promissory

review

Note 3 Bill of Exchange 4 Cheque 5 Chapter

Page 189 of 305

Sir Na

eem Ba

ig

Business Law

INTRODUCTION

Learning outcomes

The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws.

Negotiable instruments Act

LO On the successful completion of this paper, candidates will be able to demonstrate

specially and their payment modes.

References to Legal Acts

Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated:

Act Chapters

Contract Act 1872 3-16

Partnership Act 1932 17

Negotiable Instrument Act 1881 18

Securities Act 2015 22

knowledge of laws relating to Negotiable Instruments.

LO4.1.1 Define and explain terms

LO4.1.2 Explain provisions relating to types of negotiable instruments.

LO4.2.1 Describe provisions relating to crossing of cheques

LO4.2.2 Briefly describe and differentiate between a cheque crossed generally and a cheque crossed

Page 190 of 305

Sir Na

eem Ba

ig

Companies Act, 2017 19-27

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

1 MEANING AND CHARACTERISTICS OF NEGOTIABLE INSTRUMENTS Section overview

� Definition of negotiable instrument � Characteristics of negotiable instrument � Parties to negotiable instrument � Types of instrument � Endorsement � Negotiation � Payment in due course

1.1 Definition of negotiable instrument

Definition: Negotiable instruments [Section 13]

A negotiable instrument means a:

� Promissory note

� Bill of exchange or

� Cheque

payable either to order or to bearer. In simple terms, negotiable means transferable by delivery and instrument means a written document by which a right is created in favour of some person. Thus negotiable instrument may mean a written document transferable by delivery.

Thus, from the above definition it reveals that promissory note, bill of exchange and cheque can be termed as negotiable instruments.

1.2 Characteristics of negotiable instrument

The essential characteristics of a negotiable instrument are shown below:

These essential characteristics are discussed below:

Page 191 of 305

Sir Na

eem Ba

ig

Business Law

Payable to order or bearer

Payable to order

A promissory note, bill of exchange or cheque is payable to order which is expressed to be so payable or which is expressed to be payable to a particular person, and does not contain words prohibiting transfer or indicating an intention that it shall not be transferable is called payable to order. e.g. Pay A, Pay A or order and Pay A or B.

However, there is an exception in favour of cheque. A crossed cheque "Account Payee only" can still be negotiated further. Payable to bearer

Example: Payable to bearer

A cheque is payable to A. A endorses it merely by putting his signature on the back and delivers it to B with the intention of negotiating it (without making it payable to B or B’s order). In the hands of B the cheque is a bearer instrument.

Easy transferability

They are transferable from one person to another by mere delivery if payable to bearer and by endorsement and delivery if payable to order. Transferee can sue in his own name

A bill, note or a cheque represents a debt and implies the right of the creditor to recover something from his debtor. The creditor can either recover this amount himself or can transfer his right to another person. In case he transfers his right, the transferee of a negotiable instrument is entitled to sue on the instrument in his own name in case of dishonour, without giving notice to the debtor of the fact that he has become holder.

Example: Transferee can sue in his own name

A B To pay To receive

A gave a cheque to B who transfers it to C. If the cheque dishonours C can sue A in his own name without giving notice to A that he has become the holder.

Title of holder in due course

It means that once an instrument is received in the hands of holder in due course it becomes free from all defects.

Example: Title of holder in due course

A gives a promissory note to B. B lost the instrument and it was found by C. C cannot recover the amount on the negotiable instrument as he is not the holder in due course but if C transfer the instrument to D and D becomes holder in due course he can recover the amount on the instrument from A or all prior parties.

A promissory note, bill of exchange or cheque is payable to bearer which is expressed to be so payable or on which the only or last endorsement is an endorsement in blank. If an instrument is payable to any person whosoever bears it then it is called payable to bearer. Thus a note, bill or cheque in the form “Pay to A or bearer or pay bearer is payable to bearer.

Page 192 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

1.3 Parties to negotiable instrument Drawee in case of need

The person whose name is given in addition to the drawee to be referred in case of need. [Section 7]

By whom the name is given

� By the drawer while drawing the bill

� By the endorser while indorsing the bill.

Acceptor for honour

When a bill of exchange has been noted or protested for non-acceptance or for better security and any person accepts it supra protest for honour of the drawer or of any one of the endorsers, such person is called an acceptor for honour. [Section 7]

Holder

A person is called holder of a negotiable instrument if he satisfies the following two conditions:

� He must be entitled to the possession of the instrument in his own name and

� He must be entitled to receive / recover the amount due on the instrument from the parties liable under the instrument

Thus a holder means the bearer of the bearer instrument and the endorsee or payee of the order instrument. When the note, bill or cheque is lost and not found or is destroyed, the person in possession of it or the bearer at the time of loss or destruction shall deemed to continue to be its holder. [Section 8] Holder in due course

A person becomes holder in due course when he fulfils the following conditions: [Section 9] Conditions to be holder in due course

� Holder He must be a holder i.e. He fulfils the essentials of a holder.

� Holder for valuable consideration There must be a lawful and adequate consideration.

� Before maturity A person should receive the instrument before its maturity. In case of instrument payable on demand, he must have taken the instrument within a reasonable time of its issue.

� Complete and regular It is the duty of every person who takes a negotiable instrument to examine its form and contents thoroughly, for if it contains any material alteration which has not been confirmed by the drawer through his signature or it is incomplete like drawer name is missing or not properly stamped.

� Holder in good faith

A person should take the instrument without any negligence on his part and in good faith without having any reason to believe that any defect existed in the title of the transferor. If there is any suspicion and he takes the instrument without making proper inquiries he cannot be said to be acting in good faith.

Page 193 of 305

Sir Na

eem Ba

ig

Business Law

1.4 Types of instrument

Order instrument

A promissory note, bill of exchange or cheque is payable to order if either of the following two conditions is fulfilled:

� Which is expressed to be so payable or

� Which is expressed to be payable to a particular person

and does not contain words:

� which prohibit transfer or

� indicate an intention that it shall not be transferable. [Section 13] Note:

� An order instrument can be transferred by an endorsement on it and then its delivery. Bearer instrument

A promissory note of bill of exchange or cheque is payable to bearer if either of the following two conditions if fulfilled:

� expressed to be so payable, or

� last endorsement must be an endorsement in blank. [Section 13]

Note:

� A promissory note cannot be made payable to the bearer.

� A bill of exchange cannot be made payable to bearer on demand.

Inland instrument

A promissory note, bill of exchange or cheque which is:

� Made or drawn in Pakistan and also made payable in Pakistan, or

� Made or drawn in Pakistan upon any person resident in Pakistan, although it may be payable in a foreign country.

is called an inland instrument. [Section 11]

Example: Inland instrument

� A promissory note made in Multan and payable in Peshawar.

� A bill of exchange drawn in Sukkur on a person resident in Toba Tek Singh although it may be payable in Afghanistan.

Note:

� An inland instrument remains inland even if it has been endorsed in a foreign country. Foreign instrument

An instrument, which is not an inland instrument, is deemed to be a foreign instrument. [Section 12]

Example: Foreign instrument

� Promissory note made in Pakistan but payable in Myanmar.

� A bill of exchange drawn in Pakistan on a person residing outside Pakistan, and made payable outside Pakistan.

Page 194 of 305

Sir Na

eem Ba

ig

Business Law

Definition: Endorsement [Section 15]

“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 or on a slip of paper annexed to it thereto, or so signs for the same purpose a stamped paper intended to be completed as negotiable instrument he is said to endorse the same and is called the endorser.”

The term endorsement may be defined as signing one’s name on the negotiable instrument for the purpose of transferring it to another person.

Essentials of valid endorsement

� It must be on instrument itself, if no space is left on the back of the endorsement, further endorsements are signed on a slip of paper attached to the instrument called allonge.

� It must be signed by the endorser for the purpose of negotiation. Signature of the endorser on the instrument without any additional words is sufficient.

� No particular form of words is necessary for an endorsement

� It must be completed by the delivery of the instrument. The delivery of the instrument with the intention of passing the property in it.

� Negotiation by endorsement must be of the entire instrument. Endorsement for part of the amount or to two or more endorsee severally is invalid.

Definition: Negotiation [Section 14]

"When a promissory note, bill of exchange or cheque is transferred free from defects to any person, so as to constitute that person the holder of it, the instrument is said to be negotiated.

The analysis of the definition reveals that negotiation takes place when the negotiable instrument is transferred from one person to another and the transfer is made in such a manner so as to make the transferee the holder of the negotiable instrument and it must be transferred free from defects.

Means payment in accordance with the apparent tenure of the instrument in good faith and without negligence to any person in possession of it. Apparent tenure means the period of time as expressed in the instrument, after which it is payable. [Section 10]

Payment in due course, which results in discharge of a negotiable instrument, must fulfil the following conditions.

� The payment must be in accordance with the apparent tenure of the instrument. It should be made at or after maturity. A payment before maturity is not a payment in due course so as to discharge the instrument.

Example: Payment in accordance with apparent tenure

If a banker makes payment of a post-dated cheque before the date mentioned on the cheque, he acts against the apparent tenor of the instrument. Hence the payment will not be treated as payment in due course.

� The payment must be made in good faith and without negligence. It must be honestly in the bonafide belief that the person demanding the payment is legally entitled to it. The payer must not be guilty of any negligence in making the payment.

1.5 Endorsement

1.6 Negotiation

1.7 Payment in due course

Page 195 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

Example: Payment in good faith

� The payment must be made to a person in possession of the instrument under circumstances which do not arouse the suspicion about his title to possess the instrument and to receive payment of the amount therein mentioned.

� The payment must be made in money only, unless the holder agrees to accept payment in any other medium i.e. by cheque or draft.

Bill of Exchange is paid without enquiry as to the payee or cheque with forged signature of the drawer is paid will amount to negligence on the part of the payer and the payment will not be treated as payment in due course.

Page 196 of 305

Sir Na

eem Ba

ig

Business Law

2 PROMISSORY NOTE Section overview

� Definition of promissory note � Parties to a promissory note � Specimen of a promissory note

� Essential elements of a promissory note

2.1 Definition of promissory note

Definition: 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 on demand or at a fixed or determinable future time a certain sum of money only, or to the order of a certain person, or to the bearer of the instrument.

The analysis of the definition shows that, a promissory note is a written and signed promise to pay a certain sum of money to a specified person or his order.

2.2 Parties to a promissory note

Following are the two main parties in a promissory note:

Maker

It is a person who makes the promissory note and promises to pay the money stated in it. Payee

It is a person to whom the amount of promissory note is payable i.e. to whom the promise to pay is made.

Page 197 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

2.3 Specimen of a promissory note

In the specimen XYZ is the maker and ABC is the payee.

2.4 Essential elements of a promissory note

The essential elements of a promissory note are shown below:

These essential characteristics are discussed below: In writing

A promissory note has to be in writing. An oral promise to pay does not become a promissory note. The writing may be on any paper, on any book. The words used must impart a clear undertaking to pay, but it is not necessary that the word promise should be used.

Date: September 15, 2013 Rs. 10,000/- only

Three months after date I promise to pay ABC or to his order the sum of Rupees Ten Thousand, for value received

To Sign: __________ ABC XYZ Jail Road Saddar Karachi Karachi

Page 198 of 305

Sir Na

eem Ba

ig

Business Law

Example: It must be in writing

A signs the instruments in the following terms

a) “I promise to pay B or order Rs.500”.

b) “I acknowledge myself to be indebted to B in Rs.1,000 to be paid on demand, for value received”.

c) A promise to pay B a sum of Rs. 500 on telephone. This promise will not make a promissory note because it is not in writing.

In the above example (a) and (b) are promissory notes while (c) is not a promissory note.

Promise to pay

There must be a promise or a clear undertaking to pay. A mere acknowledgement of indebtedness is not a promissory note, although it is valid as an agreement and may be sued upon as such.

Example: Promise to pay

A signs the instruments in the following terms:

a) Mr. B I owe you Rs. 1,000

b) I am liable to pay to B Rs. 500

c) I have taken from B Rs.2,000 and I am accountable to him for the same with interest.

The above instruments are not promissory notes as there is no clear undertaking or promise to pay. There is only an acknowledgement of indebtedness.

Where A signs instrument in the following terms:

“I acknowledge myself to be in debited to B in Rs.1,000 to be paid on demand for value received.

There is a valid promissory note

Definite and unconditional

The promise must not depend upon the happening of some uncertain event. i.e. a contingency or the fulfilment of a condition. If an instrument contains a conditional promise to pay, it is not a valid promissory note and will not become valid and negotiable even after happening of the condition.

Example: Definite and Unconditional

A signs the instrument in the following terms:

a) I promise to pay B Rs.500 seven days after my marriage with C.

b) I promise to pay B Rs. 500 on D’s death, provided D leaves me enough to pay the sum.

c) I promise to pay B Rs. 500 as soon as I can.

The above instruments are not valid as the payment is made dependent upon the happening of an uncertain event which may never happen and as a result the sum may never become payable.

Exception

But a promise to pay is not conditional if the amount is made payable

� at a particular place or

� after a specified time or

� on the happening of an event which must happen, although the time of its happening may be uncertain.

Page 199 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

Example: Exception

If A signs an instrument stating “I promise to Pay B Rs.500 seven days after C’s death”, the promissory note is valid because it is not considered to be conditional, for it is certain that C will die one day.

Signed by maker

It is imperative that the promissory note should be duly authenticated by the signature of the maker. If the maker is illiterate he may place his thumb mark. Certain parties

The instrument point out with certainty as to who is the maker and who is the payee. Where the maker and the payee cannot be identified with certainty, the instrument even if it contains an unconditional promise to pay is not a promissory note.

A promissory note cannot be made payable to the maker himself. But if it is endorsed by the maker to some other person or endorse in blank it will become valid. Sum payable must be certain

It is essential that sum of money promised to be payable must be certain and definite. The amount payable must not be capable of contingent addition or subtraction.

Example: Sum payable must be certain

A signs instrument in the following term

a) I promise to pay B Rs.500 and all other sums which shall be due to him

b) I promise to pay B Rs.500 and all fines according to rules.

The above instruments are invalid as promissory notes because the exact amount is not certain. Sum payable must be legal tender

A promise to pay a certain amount of foreign or to deliver a certain quantity of goods is not a promissory note. Thus, an instrument signed by A, “I promised to pay B Rs.500 and to deliver him my black horse” is not a valid promissory note.

Page 200 of 305

Sir Na

eem Ba

ig

Business Law

3 BILL OF EXCHANGE Section overview

� Definition of bill of exchange � Parties to a bill of exchange � Specimen of a bill of exchange

� Essential elements of a bill of exchange

3.1 Definition of bill of exchange

Definition: 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 on demand or at a fixed or determinable future time a certain sum of money only, to or to the order of, a certain person, or to the bearer of the instrument.”

3.2 Parties to a bill of exchange

Following are the three main parties in a bill of exchange:

Drawer

It is a person who draws a bill of exchange. Drawee

It is a person who is ordered to pay the amount of the bill of exchange (on whom the bill is drawn). When drawee accepts the bill of exchange (when he gives consent to make the payment) he is called the acceptor. Payee

It is a person to whom the amount of bill of exchange is payable.

The analysis of the definition shows that, a bill of exchange is a written and signed order directing a person to pay a certain sum of money to the bear of the instrument or to a specified person or his order. Generally, a bill of exchange is drawn by a creditor, who directs his debtor to pay the money to the person specified in the instrument.

Page 201 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

3.3 Specimen of a bill of exchange

In the specimen MNO is the drawer, ABC is the drawee and XYZ is the payee.

3.4 Essential elements of a bill of exchange

The essential elements of a bill of exchange are shown below:

These essential characteristics are discussed below: In writing

A bill of exchange is required to be in writing. Like promissory note, a bill of exchange also cannot be oral. Order to pay

A bill of exchange contains an order to pay instead of a promise to pay like in promissory note. This feature distinguishes it from promissory note. Further, a request to pay money is not considered to be a bill of exchange.

Date: September 15, 2013 Rs. 10,000/- only Three months after date pay to XYZ or to his order the sum of Rupees Ten Thousand, for value received.

Accepted ABC

To Sign: __________

ABC MNO Jail Road Saddar

Karachi Karachi

Page 202 of 305

Sir Na

eem Ba

ig

Business Law

Example: Order to pay

The following instruments signed by A are valid bills of exchange as they contain an order to pay, though the language used is very polite:

a) B, please pay Rs. 500 to C or order.

b) B will much oblige me by paying to C Rs. 500.

The following instruments signed by A are not valid bills of exchange as they contain only a request to pay and no order to pay:

a) B, please let C have Rs.500, and place it to my account and oblige,

b) B, I shall be highly obliged if you make it convenient to pay Rs.1,000 to C.

Definite and unconditional

In other words, the order to pay should not depend upon a condition or upon the happening of an uncertain event. This point has already been discussed in detail in case of a promissory note. Signed by drawer and drawee

The instrument must be signed by the drawer and drawee. Certain parties

All the parties must be certain i.e. indicated in a bill of exchange with reasonable certainty. Sum payable must be legal tender

If the instrument contains an order to pay something other than money or something in addition to money, it will not be valid bill of exchange. Sum Payable must be certain

It is essential that sum of money ordered to be payable must be certain and definite. The amount payable must not be capable of contingent addition or subtraction.

Page 203 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

4 CHEQUE Section overview

� Definition of cheque � Parties to a cheque � Specimen of a cheque

� Essential elements of a cheque

� Method of crossing

� Types of crossing

� Crossing of a cheque after issue

� Protection to the collecting banker

4.1 Definition of cheque

Definition: Cheque [Section 6]

Cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand.

The analysis of the above definition reveals that a cheque is a bill of exchange but is different in following two characteristics:

� Drawee will always be a banker

� Always payable on demand

4.2 Parties to a cheque

Page 204 of 305

Sir Na

eem Ba

ig

Business Law

Following are the three main parties in a cheque: Drawer

It is a person who draws a cheque. Drawee

It is a banker who is ordered to pay the amount of the cheque. Payee

It is a person to whom the amount of cheque is payable.

4.3 Specimen of a cheque

4.4 Essential elements of a cheque

The essential elements of a cheque are shown below:

These essential characteristics are mentioned below:

ABC Bank Limited Date: September 15, 2013 Main Branch, Karachi Cheque no:______ Pay _____________________________________________________ OR BEARER Rupees _______________________________________ Account no: _____________ Title of account

Do not write below this line

Rs.

Signature

Page 205 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

� It must be in writing

� There must be an express order to pay and not a request to pay

� The order must be definite and unconditional

� It must be signed by the drawer

� The three parties (drawer, drawee and payee) must be certain.

� The order must be to pay a certain sum

� The order must be to pay money only

� It must always be drawn upon a specified banker

� It must always be payable on demand

4.5 Method of crossing

A cheque is said to be crossed when it bears across its face two parallel transverse lines which are usually drawn on the left hand top corner of the cheque. It is an instance of an alteration which is authorised by the Act. A crossing is a direction to the director of the paying banker not to pay across the counter. Purpose of crossing

The purpose of crossing is to direct the drawee (banker) to pay the amount of the cheque only to a banker so that the party who receives the payment can easily be traced.

4.6 Types of crossing General crossing

A cheque is said to be crossed generally where it bears across its face an addition of:

� The words “and company” or any abbreviation of it between two parallel transverse lines. [Section 123 ]

Effect of general crossing

When a cheque is crossed generally the banker on whom it is drawn shall not pay it otherwise than to a banker. [Section 126]

Example: General crossing

Special crossing

A cheque is said to be crossed especially where it bears across its face an addition of:

� Name of the banker

� Parallel lines are not necessary. [Section 124] Effect of special crossing

When a cheque is crossed specifically the banker on whom it is drawn shall not pay it otherwise than to a banker to whom it is crossed or his agent for collection. [Section 126]

Page 206 of 305

Sir Na

eem Ba

ig

Business Law

Example: Special crossing

Restrictive crossing

Restrictive crossing may be added with general crossing by adding the words “A/c Payee” or “A/c Payee only”. [Section 123A] Effect of restrictive crossing

Strictly speaking, the amount collected on the cheque must be credited only to the account of payee.

Example: Restrictive crossing

Not negotiable crossing

Example: Not Negotiable Crossing

4.7 Crossing of a cheque after issue

A cheque may be crossed after its issue in the following manner: [Section 125]

Case Right to cross

Where a cheque is uncrossed The holder may cross it generally or specially.

Where a cheque is crossed generally The holder may cross it specially by adding the name of the banker.

Where a cheque is crossed generally or specially

The holder may add the word “Not negotiable”.

Where a cheque is crossed specially The banker to whom it is crossed may again cross it especially to another banker (his agent) for collection.

The effect of the words “not negotiable” on a crossed cheque is that the title of the transferee of such a cheque cannot be better than that of its transferor. The addition of the words not negotiable does not restrict the further transfer ability of the cheque. It only takes away the main feature of negotiability, which is transferability free from defects. Therefore, a holder with a defective title cannot give a good title to a subsequent holder. The object of crossing a cheque not negotiable is to afford protection to the drawer or holder of the cheque against miscarriage or dishonesty in the course of transit by making it difficult for the cheque so crossed cashed, until it reaches its destination. [Section 130]

Page 207 of 305

Sir Na

eem Ba

ig

Section A: Mercantile Law - Chapter 18: Negotiable instruments act

4.8 Protection to the collecting banker

A collecting banker is one who receives the payment of a crossed cheque on behalf of his customer. If the collecting banker has collected a cheque on behalf of a person whose title to the cheque was defective, he would be protected and would not be held liable in conversion to the true owner, provided he proves that:

� He acted in good faith and without negligence

� The cheque was already crossed before it reached his hands and

� He received the payment on behalf of a customer and not on his own account i.e. he acted as an agent for collection and not in the capacity of holder for value.

It may be noted that if the banker credits his customer’s account with the amount of the cheque before receiving payment, he does not become a holder for value and the protection shall be available to such a collecting banker as well. This protection is not available where the banker allows the proceeds of an “Account payee crossed cheque” to be credited to any account other than the payee and the endorsement in favour of the last payee is proved forged.

The protection afforded to the collecting banker is very valuable in view of the fact that when one person deals with the goods of another without his permission, he is liable to an action for conversion and in the absence of this protection the position of the banker would not be different from that of any other person. [Section 131]

Page 208 of 305

Sir Na

eem Ba

ig

Business Law

REVIEW Chapter review

Before moving on to the next chapter check that you now know how to:

� Define the term negotiable Instrument and different types of negotiable Instrument

� Discuss the essential characteristics of Negotiable Instrument

� Understand the effect of crossing a cheque and various types of crossing

5 CHAPTER

� Explain the terms Holder, Holder in due course, Negotiation and Endorsement

� Discuss the protection granted to the collecting banker

Page 209 of 305

Sir Na

eem Ba

ig