Subject Commerce Paper No and Title 10: Corporate Legal

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PAPER No.10: Corporate Legal Framework

MODULE NO.19: Basics of Negotiable Instruments

Subject Commerce

Paper No and Title 10: Corporate Legal Framework

Module No and

Title

19: Basics of Negotiable Instruments

Module Tag COM_P10_M19

TABLE OF CONTENTS

1. Introduction: Money facilitates economic exchanges

2. Meaning of negotiable instrument

3. Features

4. Definition

5. Kinds of negotiable instruments:

a. Promissory note

b. Bill of exchange

c. Cheque

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d. Other negotiable instruments

e. Documents not negotiable instruments

f. Hundis

6. Government monopoly over issue of currency

7. Promissory note:

a. Definition

b. Specimen

c. Parties

d. Essentials

8. Bill of exchange

a. Definition

b. Specimen

c. Parties

d. Essentials

9. Cheque

a. Parties to a Cheque.

b. Essentials ofa Valid Cheque.

c. Bank Draft

10. Classification of Negotiable Instruments:

a. Inland and Foreign Instruments

b. Bearer and Order Instruments

c. Demand and Time Instruments

d. Escrow

11. Maturity of Negotiable Instruments

LEARNING OUTCOMES

This module will enable you to understand:

a. The role played by the negotiable instruments in the world of business;

b. The meaning and features of a negotiable instrument;

c. The most common kinds of negotiable instruments;

d. The detailed features of a promissory note, bill of exchange and cheque;

e. A brief idea of various classifications of negotiable instruments;

f. The meaning of maturity date of negotiable instruments.

1. INTRODUCTION

Money facilitates economic exchanges:

When we go to the market to do shopping, we keep with us a certain quantity of money

which will enable us to obtain the required goods or services from the market. We never

think why the suppliers of these goods or services are ready to accept these currency

notes or coins in exchange of the goods and services; theydo so because they know they

will be able to obtain goods or services for their business or domestic needs in exchange

of the same money. This universal acceptability of money as a valuable thing in a given

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society is what gives to it the value that people attribute to

it. The value of all the goods or services can be expressed in terms of money.

In the earlier stages of civilization, barter system was the primary mode of exchanging

goods and services. Before the use of paper currency began during the medieval

centuries, the metallic coins issued by kings served the role of currency in many societies.

During those pre-paper-currency times, the trading communities too had developed the

usage of their private paper instruments to facilitate trade. You may be aware that in

India, the usage of indigenous instruments such as Hundis dates back to ancient times. In

Europe, such paper instruments, called the bills of exchange have been in use since early

medieval times.

Modern times saw the emergence of paper currency in many countries. This facilitated

the expansion of commerce and trade to distant places. But, this paper currency alone

could not keep the wheels of business operations going full steam. The non-money paper

instruments whose use had started among traders even before the advent of paper

currency, came up for wider use during modern times. These instruments in various

forms such as, the bills of exchange, cheques, bank drafts, hundis etc.were augmenting

the support provided to trade by money.

These instruments, used as supplements to money, are known as NEGOTIABLE

INSTRUMENTS.

The word ‘negotiable’ means transferable by delivery. The word ‘instrument’ means any

document defining certain rights and duties.

Money-holding and money-transfer are essential requirements of the economic world.

The negotiable instruments have helped in serving these needs of the trading world. With

the emergence of information technology and internet, more innovations have taken place

in methods to hold money and transfer it.

Law governing the creation and use of negotiable instruments is contained in The

Negotiable Instruments Act, 1881.

Let us now enter into the technical areas of negotiable instruments.

2. MEANING OF NEGOTIABLE INSTRUMENT

A negotiable instrument is one 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.

A negotiable instrument has some essential features. Rather, we should say – it is because

of these features only that an instrument takes the form of a negotiable instrument. And,

mind you, these features get into an instrument not because some law says so, but

because the continuous practices of the trading world grant these features to the

instruments.

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3. FEATURES OF A NEGOTIABLE INSTRUMENT

1. A negotiable instrument is in writing and signed by its maker.

2. It carries a monetary value.

3. It contains an unconditional promise or order to pay some money.

4. It is about a fixed amount of money only.

5. It is transferable easily from one person to another any number of times.

6. The transferee of a properly made and acquired negotiable instrument has the right to

recover the amount mentioned in the instrument in his own name.

7. A transferee of a negotiable instrument acquires a title over the instrument which can

be superior to the title of the transferor which may be defective in some

circumstances

4. DEFINITION (as per SEC.13)

A negotiable instrument means a promissory note, bill of exchange or cheque payable

either to order or to bearer.

5. KINDS OF NEGOTIABLE INSTRUMENTS

Promissory note It is a negotiable instrument which is made by a person liable to pay. It contains an

unconditional promise by its maker to pay a certain sum of money to another person.

Bill of exchange

It is a negotiable instrument which is drawn by the person entitled to receive a payment.

It contains an unconditional order directing a certain person to pay a certain sum of

money to the bearer of the instrument or to a specified person.

Cheque

It is negotiable instrument containing an unconditional order to a specified banker to pay

a certain sum of money to the bearer of the instrument or to a specified person.

Other negotiable instruments Every document which fulfils the requirements of a negotiable instrument is recognized

by the usage or custom as the negotiable instrument.

Examples:

Hundis, treasury bills, banker’s drafts, share warrants, dividend warrants, bearer

debentures, and Government Promissory Notes, Port Trust or Improvement Trust

debentures

Documents not negotiable instruments

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Certain types of documents carry some monetary value

which can be transferred. But, the transfer takes place as ordinary goods and not as

negotiable instruments.

Examples:

Share certificates, postal orders, money orders, deposit receipts, letters of credit, bill

of lading, railway receipts, dock warrants.

Please note that the last three of these are called quasi-negotiable instruments because

they can be transferred by delivery or endorsement and delivery, but their weakness is

that the transferee can never get a title better than that of the transferor.

Hundis

A Hundi (or a rukka) is the traditional Indian negotiable instruments being used since

ancient times for transfer or payment of money. Hundis are written in a local Indian

language. A hundi may be made in the form of a bill of exchange or a promissory note.

Hundis are subject to local usages but would be affected by the provisions of the

Negotiable Instrument Act, 1881 also.

6. GOVERNMENT MONOPOLY OVER ISSUE OF CURRENCY

A negotiable instrument, particularly, a promissory note, if issued by a renowned person

can acquire wide acceptability in market, similar to that available to a currency note. It is,

however, necessary to maintain the monopoly of the Central Government over the issue

of national currency. Provisions of the Reserve Bank of India Act, 1934, particularly

Sec.31, ensure this monopoly. Through these provisions, it is laid down that certain types

of instruments which have the potential to look like currency can be issued by the

Reserve Bank of India or the Central Government.

7. PROMISSORY NOTE

A ‘promissory note’ is made by a person liable to pay an amount. Through this

instrument a promise is made in writing by a person who has to pay a certain sum of

money to a specified person.

Definition: Sec.4- 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 only to, or to the order of a certain person, or to the bearer of the

instrument.

Specimen of a promissory note:

Rs.20,000 Bangalore, May 15, 2013

Two months after date, I promise to pay P or order the sum of

Rupees Twenty Thousand only, for value received.

To P

Hyderabad Stamp Sd/- M

R

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There are certain formalities, such as date, place etc.

which are usually found in a promissory note. The promissory note must be properly

stamped for a value depending on the amount of the note as required under the Indian

Stamp Act, 1899 and each stamp must be duly cancelled also.

Valid promissory notes:

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

(b) I acknowledge myself to be indebted to B in Rs 1000, to be paid on demand for value

received.

(c) I have received the sum of Rs 10000 from B. This amount will be repaid on demand. I

have received this amount in cash.

Invalid promissory notes:

(a) Shri Hari, I.O.U. (I owe you) Rs 500.

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

(c) I promise to pay B Rs 500, first deducting there out any money which he may owe

me.

(d) I acknowledge my liability to pay Rs.1000 to J.

Parties to a promissory note: (a).Maker. This is the person who makes the promissory note and promises to pay the

money stated therein.

(b). Payee. This is the person to whom the amount of promissory note is payable i.e. to

whom the promise to pay is made.

Essentials of a Valid Promissory Note:

1. It must be in writing and includes printing and typewriting.

2. It must contain an express and not an implied promise to pay money.

The word ‘promise’ may not necessarily be used.

3. The promise to pay must be definite and unconditional.

The following instruments signed by G do not become valid promissory notes:

(a) “I promise to pay B Rs.1000 one month after A’s marriage with C”. It is an uncertain

promissory note because A may never marry C.

(b) “I promise to pay B Rs.1500 on C’s death, provided C leaves me enough to pay that

amount”. In this case also, though the death of a person is a certainty, the payment is

conditional.

(c) “I promise to pay K Rs 2000 as soon as possible”. It is an uncertain statement.

But where an instrument is made payable on the happening of a definite event, the

instrument is valid because there is no uncertainty regarding its payment.

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Example. A person signed an instrument in the words:

“I promise to pay S Rs.2500 after a month of C’s death”. It is a valid promissory note

because the death is a certain event.

4. It must be signed by its maker. If the maker is illiterate, he may put his thumb mark.

5. It must contain a promise to pay in terms of legal currency i.e. money only and not in

kind.

6. It must have promise to pay a definite amount of money. The amount of money stated

in the note must be definite and not uncertain.

Where the determination of the amount is to be based on some interest calculation or an

exchange rate or that the payment would be in installments, the promissory note shall be

valid.The following is a valid promissory note

I promise to pay S Rs.8000 in 16 monthly installments of Rs 500 each on the first

of every month. If I default in any installment on the due date, the whole balance

unpaid shall become due.

7. The parties to the promissory note must be certain. Both the parties, the maker and the

payee, must be identified on the face of the instrument. However, the parties may be

described by name or by designation, e.g. manager of a bank, the managing director of a

company etc.

Where, however, in a promissory note or a bill of exchange, the drawee or payee is mis-

named or mis-spelt, extrinsic evidence shall be admissible to identify him.

8. BILL OF EXCHANGE

A ‘bill of exchange’ is an order in writing asking a person to pay a sum of money to a

specified person.

Definition: Sec.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 only to, or to the order of a certain person or to the bearer of the instrument.

Generally, a bill of exchange is drawn by a creditor upon his debtor as a conditional

payment of his money.

Parties to a bill of exchange: 1. Drawer. This is a person who draws the bill of exchange. He is the maker of the bill.

2. Drawee. This is the person on whom the bill is drawn, the person who is ordered to

pay the amount of the bill of exchange. When the drawee ‘accepts’ the bill of exchange

(i.e. when he gives his written consent to make the payment of the bill on its due date), he

becomes the ‘acceptor’ and liable on it.

It may be noted that a bill can be negotiated even before its acceptance. If acceptance is

refused by the drawee, it becomes dishonored by non-acceptance.

3. Payee. This is a person to whom the amount of the bill of exchange is payable.

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Where the bill is made payable to the payee ‘only’, it will

not remain a negotiable instrument although it shall be valid bill.

Specimen of a bill of exchange

Rs.20,000 Bangalore, June 11, 2013

Two months after date, I promise to pay K or order the sum of

Rupees Twenty Thousand only, for value received.

To K

Hyderabad Stamp Sd/- R

Sometimes, the drawer and the payee may be the same person, e.g. when a person

writes a bill of exchange as ‘pay to the undersigned or order’. Sometimes, the drawer and

the drawee may also be the same person, e.g. a bill of exchange drawn by one branch of a

firm on its other branch. In such cases the holder of the bill may treat it, at his option,

either as a bill of exchange or as a promissory note (Sec. 17).

The drawee can give his ‘acceptance’ to the bill of exchange by writing a word, such

as, ‘accepted’ and putting the signatures or by simply putting his signatures on the bill

of exchange.

Essentials of a Valid Bill of Exchange:

Although, the bill of exchange and the promissory note are differentin their form, the

essential requirements for a valid bill of exchange are more or less the same.

It may be noted that the bill of exchange must contain an express order to pay money and

not a mere request.

Valid bills of exchange:

(a)Shri Ved, please pay Rs 1500 to C or order.

(b) Shrimati Jaya, please pay to C or order Rs 1500 and oblige me.

Invalid bills of exchange:

(a) Mr P, please let G have Rs 5000 and place it in my account and oblige.

(b) Mr S, I shall feel obliged if you make it convenient to pay Rs 7000 to R.

9. CHEQUE

A cheque is a peculiar kind of bill of exchange. It is a bill of exchange which is drawn

upon a banker and is always payable on demand.

The amendment in the year 2002 has recognized an electronic cheque or the electronic

image of a truncated cheque also as a cheque. Sec. 6, which has given the definition of

the term ‘cheque’, now reads as follows:

Definition: Sec.6- 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.

Explanation:

(a) “A cheque in the electronic form” means a cheque which contains the exact mirror

image of a paper cheque, and is generated, written and signed in a secure system ensuring

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the minimum safety standards with the use of digital

signature (with or without biometrics signature) and asymmetric crypto system;

(b)A “truncated cheque” means a cheque which is truncated during the course of a

clearing cycle, either by the clearing house or by the bank whether paying or receiving

payment, immediately on generation of an electronic image for transmission, substituting

the further physical movement of cheque in writing.

A cheque as a bill of exchange has following two additional features:

1. A cheque is always drawn on a specified bank, and

2. A cheque is always payable on demand.

Parties to a Cheque: 1. Drawer. This is the person who draws the cheque. He is the maker of the cheque.

2. Drawee. This is the banker on whom the cheque is drawn and who is directed to pay

the amount of the cheque.

3. Payee. This is the person to whom the amount mentioned in the cheque is made

payable.

In many cases, the drawer and the payee may be the same person, e.g. where a

person draws a cheque ‘payable to self’.

Essentials of a Valid Cheque: 1. It must have all the essentials of a bill of exchange being itself a bill of exchange.

2. It must be drawn on a specified banker. A cheque drawn on any person other than a

banker is not valid.

3. It must be payable on demand.

A cheque is not required to be ‘accepted’ by the drawee bank. Moreover, a cheque is

also not required to be stamped.

Bank Draft:

A ‘Bank Draft’ is an order issued by a bank on another bank or on its own branch at

another place to pay the stated amount to the specified person or his order. It is also a

negotiable instrument and is just like a cheque

10. CLASSIFICATION OF NEGOTIABLE INSTRUMENTS

Inland and Foreign Instruments:

Inland instruments: Sec.11- A promissory note, bill of exchange or cheque drawn or

made in India, and made payable in, or drawn upon any person resident in India, shall be

deemed to be an inland instrument.

Examples:

(a) An instrument drawn in Mumbai and payable in Kolkata.

(b) A bill drawn in Goa on R, a person resident in India, but made payable outside India.

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Foreign instruments: Sec.12- Any such instrument not so

drawn, made or made payable [as an inland instrument] shall be deemed to be a foreign

instrument.

Examples:

(a)A bill drawn in India on K, a merchant residing in London and made payable in

London.

(b)A bill drawn in London on J, a merchant residing in London but made payable in

India.

(c) A bill of exchange drawn in USA and payable in Egypt.

(d) A promissory note (but not a bill or a cheque) made in India on H, a resident of India,

but payable in Tokyo.

Bearer and Order Instruments:

Bearer instrument: Sec.13 (1) – 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 the last

endorsement is an endorsement in blank.

The term ‘bearer instrument’ means an instrument whose payment can be taken by

any person who has the lawful possession of the instrument. It is not necessary that the

instrument should mention his name. However, when he receives payment, he would be

required to acknowledge receipt of money by signing on the instrument.

Examples:

(a) “Pay to A or bearer”

(b) “Pay the bearer”

Order instrument: An instrument would be payable to order,

(a) Where the instrument is expressed to be payable to a particular person or according

to the order of that person;

(b) Where the instrument is expressed to be payable to a particular person and which

does not contain any words restricting its further transfer.

An order instrument is also negotiable (i.e. transferable). But it can be negotiated by

an endorsement on it and then its delivery.

The negotiable instruments, containing the following words are ‘order’ instruments:

(a) “Pay to A or order”,

(b) “Pay to the order of A”,

(c) “Pay to A”.

A negotiable instrument made in the words ‘Pay to P only’ is not an order

instrument.

Demand and Time Instruments:

Demand Instrument: Sec.19– A promissory note or bill of exchange in which no time

for payment is specified, and a cheque are payable on demand.

A ‘demand instrument’ may be described as the instrument in which the holder need

not wait for payment and can demand it as and when he chooses to do that.

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In a promissory note or bill of exchange the

expressions payable ‘at sight’ and ‘on presentment’ means payable on demand (Sec.21).

A cheque is always payable on demand.

Time instruments. A ‘time instrument’ means the instrument which is payable in future

sometime after it is made. The following instruments are time instruments:

A promissory note or a bill of exchange which is payable after a fixed period, e.g.

ninety days after sight or after date; or on a specified day; or on the happening of a

definite event.

The expression ‘after sight’ means after having been seen. In a promissory note, it

means that the payment cannot be demanded on the promissory note till it has been

shown to the maker. And in the case of a bill of exchange, the expression ‘after sight’

means ‘after acceptance’.

The expression ‘after date’ implies ‘after the date’ specified on the instrument.

Escrow:

Sometimes, a negotiable instrument is delivered conditionally, or for a special purpose as

a collateral security, or for safe custody only, and not for the purpose of transferring its

ownership. In such cases, it is called an escrow. It may be noted that in case of such

instruments, there is no liability of the parties to pay the amount of the instrument unless

the conditions agreed upon are satisfied, or the purpose for which the instrument is

delivered is fulfilled. However, the rights of ‘holder in due course’ are not affected.

11. MATURITY OF NEGOTIABLE INSTRUMENTS

‘Maturity’ of an instrument means the date at which its payment falls due (Sec.22). An

instrument made to be payable ‘on demand’ or ‘at sight’ or ‘on presentment’, such as a

cheque, becomes payable immediately on the date of its execution and there is no need to

work out its maturity date.

The need to calculate the maturity date would arise only where the instrument is

expressed to be payable otherwise than on demand.

And the maturity date is the third day after the day on which it is expressed to be

payable. These three days are called ‘days of grace’.

For example, if a bill of exchange drawn on 20th March, is expressed to be payable

two months after date, i.e. on 20th May, it would be at maturity on 23rdMay. This way, it

has to be presented for payment on the last day of grace.

A presentment for payment before the third day of grace is also invalid.

Detailed rules for calculating maturity:

1. An instrument dated 10th August, is made payable three months after date. The

instrument is at maturity on the 13th November.

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2. An instrument dated 30th November, 1998 is made

payable three months after date. The instrument is at maturity on the third day after the

28th February 1999 (i.e., 3rd March 1999).

A bill of exchange dated 27th January, 1992 is made payable one month after date. The

instrument is at maturity on the 1st March, 1992

3. A bill of exchange dated 20th September is made payable 15 days after date. The

period of 15 days will be counted from 21st September, and the bill will be at maturity on

8th October.

A bill of exchange dated 11thFebruary, 1996 and payable 25 days after sight is presented

for acceptance on the 18thFebruary, 1996. The bill shall mature on 17thMarch, 1996

(counting the days from 19th February and keeping in mind the 29 days in this month).

4. If the date on which a bill or note is at maturity happens to be a public holiday, the

instrument shall be deemed to be due on the next preceding business day, i.e. a day

earlier.

SUMMARY

A negotiable instrument is one 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.

A negotiable instruments has the following features: written and signed by its maker,

carries a fixed monetary value with an unconditional promise, freely transferable.

The transferee has the right to recover the amount and acquires a title over the

instrument.

Kinds of negotiable instruments include; Promissory note, Bill of exchange, Cheque

and other types like hundi, treasury bills, share warrants etc.

Government has the monopoly over the issue of currency.

Classification of Negotiable Instruments: Inland and Foreign; Bearer and Order;

Demand and Time; Escrow.