MODULE 2

NEGOTIABLE INSTRUMENTS

Negotiable instrument act 1881

 It extends to the whole of India except the state of Jammu and Kashmir.
 The act came into force on 1st march 1880
 It is recently amended by ― the banking, public financial institutions and
negotiable instruments laws (amendment) act 1988‖

Meaning

 There are certain documents which are freely used in commercial transactions is called
Negotiable instruments
 It is a written document which create a right in favour of some person and which is
freely transferable.
 these are money/ cash equivalents can be converted into liquid cash subjects to certain
conditions
 It is a document guaranteeing the payment of a specific amount of money, either on
demand, or at a set time.
 It is a written document which creates a right in favour of some person and which
is freely transferable.
 It is a written promise or order to pay money which may be transferred from one person
to another

Definition

 According to justice willis a negotiable instrument is ― one, the property in which is

acquired by anyone who takes it bonafide and for value not withstanding any defect in
the title of the person from whom he took it”
 According to section 13 of the negotiable instruments act 1881, a “negotiable
instrument” means a promissory note, bill of exchange or cheque payable either to order
or to bearer

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  A negotiable instrument may be made payable to two or more payees jointly, or it may
be made payable in the alternative to one of two, or one or some of several payees.
 The act recognizes three instruments as negotiable instruments, ie. Promissory note,
cheque and bill of exchange. But it does not exclude those instruments which satisfy the
conditions of negotiability. The conditions are;
1. The instrument should be freely transferable by the custom of trade
2. The person who obtains it in good faith and for value gets it free from all
defects, and thus, is entitled to recover the money of the instrument in his own name
 Special features/characteristics of negotiable instruments
 Freely transferable
 Negotiability
 In writing
 Un conditional order or promise
 Payment of certain sum of money
 Time of payment
 The payee must be a certain person
 A negotiable instrument must bear the signature of its maker
 Delivery of the instrument is essential
 Stamping of bills of exchange and promissory notes is mandatory
 The negotiable instrument was duly stamped
 Types of negotiable instruments
a. Instruments negotiable by law
1) Promissorynotes
2) Bills of exchange
3) Cheque
b. Instruments negotiable by custom or usage of trade
1) Hundies
2) Bank draft
3) Dividend warrant
4) Share warrant
5) Postal order
6) Railway receipt

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Promissory note

 It is a written promise to a pay a debt. It is a financial instrument, in which one party

(maker or issuer) promises in writing to pay determinate sum of money to the other (the
payee), either at a fixed, determinable future time or on demand of the payee subject to
specific terms.
 A promissory note is an instrument of credit which possess the characteristics of
negotiability.
 It is signed document containing a written promise to pay a stated sum to a specified
person or the bearer at a specified date or on demand.
 This can be either payable on demand or at a specified time.
 If the promissory note is unconditional and readily salable, it is called negotiable
instrument.
 As per section 4 of the negotiable instrument act a promissory note is “an instrument in
writing (not being a bank note or a currency note) containing 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”
 Essential characteristics of a promissory note
 It must be in writing
 The promise to pay must be unconditional
 The amount promised must be certain and a definite sum of money
 The instrument must be signed by the banker
 The maker must be a certain person
 The person to whom the promise is made must be a definite person
 It should be payable on demand or after a certain period
 Delivery of document is essential
 It must be properly stamped as required by the indian stamp act
 Parties to a promissory note
1) The maker or drawer
2) The payee
3) The endorser
4) The endorsee

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Bill of exchange

 as per 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 only to, or to the order of, a certain person or to the bearer of the instrument‖
 It is a written acknowledgement of the debt, written by the creditor and accepted by the
debtor. It is called a draft before its acceptance. It has to be accepted either by the person
upon whom it is drawn or by someone else on his/her behalf
 The essentials of a bill of exchange are:
 Number of parties
 Must be writing
 It must be signed by the drawer
 Express order to pay
 Order must be unconditional
 Order to pay money only
 Sum payable to be certain
 Parties
 Must be signed
 Acceptance
 Must bear the stamp
 Other formalities
 Requisites of a contract to be compiled with
 Classification of bill of exchange
a) On the basis of period of bills
1) Demand bills
2) Term bills
b) On the basis of purpose of writing the bills
1) Trade bills
2) Accommodation bills
c) Inland bills
d) Foreign bills
 Parties to a bills of exchange
 Drawer

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  Drawee
 Payee
 Acceptor
 Endorser
 the endorsee
 The holder
 Drawee in case of need
 Acceptor of honour

Acceptance

 Drawee is buyer of the goods upon whom the bill of exchange is drawn
 If the drawee is ready to make payment on due date, he has to write the word
―accepted‖ in the bill and put his signature on it
 After writing the word ―accepted‖ and putting signature, the drawee of the bill is known
as acceptor. This process is called acceptance.
 After acceptance, the bill becomes a valid legal document
 There are two types of acceptance namely general acceptance and qualified acceptance
 The general acceptance requires signatures of the acceptor only without stating
any conditions
 A qualified acceptance varies the express terms of the bill as originally drawn and
thereby the drawer can refuse to consider the bill as accepted

Cheques

 When customer opens a current and savings account , the bank provided a cheque book
for operating his account
 A cheque book contains 10 or 20 printed blank cheque leaves serially numbered
 A cheque is a negotiable instrument. It is transferable either by mere delivery or by
endorsement and delivery.
 It gives a good and absolute title to the transferee who takes it good faith and for vale and
without notice to the fact that any defect is existed in the title of the transferor.
 Section 6 of the negotiable instrument act 1881 defined a cheque as “ a bill of
exchange drawn on a specified banker and not expressed to be payable otherwise on
demand”
 A cheque is always drawn on a specified banker

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  It is always payable on demand
 specimen of cheque

 Parties to the cheque

 Drawer
 Drawee
 Payee
 Essential features of a cheque or requisites of a valid cheque
 Instrument in writing
 An unconditional order
 It is always drawn on a specified banker
 It is drawn only by the customer of a bank
 It must be signed by the drawer
 The order must be for the payment of money
 A certain sum of money only
 Payable on demand
 Payee should be a certain person

 Difference between a cheque and bill of exchange

Cheque Bill of exchange
Always drawn on a printed form Need not be drawn on a printed form
It doesn‟t require acceptance Acceptance by the drawee is essential
It may be drawn only on a banker It can be drawn on an person
including Banker
It is always payable on demand It is payable on demand or after date
It can be crossed It cannot be crossed

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 Days of grace is not allowed Days of grace is allowed
It may be countermanded It cannot be countermanded
It can be made payable to bearer It can be made payable only to order
It is used a means of payment It used for financing trade
It cannot be protest or noted on dishonour It is usually protested noted on dishonour

 kinds of cheques
1.Bearer cheques
2.Order cheques
3.MICR cheques
4.Truncated
cheque
5.Electronic
cheque
 Cheque truncation – cheque truncation system (CTS)
 Cheque truncation means that the physical cheque is scanned at the bank of first deposit
(presenting bank) and thereafter the electronic image of the cheque is sent to the clearing
house for sorting and then routing onwards to the drawee/paying bank
 CTS is a cheque clearing system undertaken by the RBI for quicker cheque clearance
 Dating of cheque
 Writing the date on the face of the cheque is known as dating of cheques
 Generally the drawer of a cheque writes the date before it is issued. If he doesn‟t do so the
cheque will not become invalid.
 The payee or any subsequent holder can fill the date. The date should be complete in
all aspects
 Ante – dated cheque
A cheque which bears a date earlier to the date of issue is known as ante- dated cheque
 Post-dated cheque
A cheque bears a date which is yet to come is called post –dated cheque
 Stale cheque
A cheque which is not presented for payment within reasonable period of time is called a
stale cheque
 Mutilated cheque
If a cheque is torn into two or more pieces, it is called mutilated cheque
 Holder of a cheque

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  Section 8 of the negotiable instrument act 1881 defines the holder of a negotiable
instrument as ―any person who is entitled in his own name to the possession thereof and
to receive or recover the amount due thereon from the parties thereto‖
 a person becomes the holder of a negotiable instrument, if he satisfies the following
conditions;
1. To be a holder, one need not possess the instrument. But he should be entitled to possess
the instrument in his own name
2. In order to be entitled to the possession of the instrument in his own name, the person must
be named in the instrument as a payee or endorsee or he must be the bearer of the instrument
3. He should have the actual or constructive possession of the instrument lawfully.
4. Mere physical possession is not sufficient. He must be entitled to receive and recover
the money from the parties concerned
 Holder in due course
 Section 9 of the negotiable instrument act 1881 defines holder in due course as
―any person who, for consideration, became the possessor of the instrument before the
amount mentioned in it became payable, and without having sufficient cause to believe
that any defect existed in the title of the person from who derives his title‖
 A person can became a holder in due course only if he satisfies the following conditions;
1. He must obtain the possession of the instrument as a payee or endorsee in the case of
an order instrument and bearer in the case of a bearer instrument
2. The instrument must have been obtained for valuable consideration that is by paying
to the full value
3. The instrument must be obtained before its maturity
4. He must obtain the instrument in good faith and without sufficient cause to believe that
any defect existed in the title of the transferor

 Differences between holder and holder in the due course

Holder Holder in due course
A holder of a negotiable instrument need A holder in due course must be a holder
not Necessarily be a holder
A holder might have obtained the A holder in due course must obtain the
instrument Without any consideration Instrument for valuable consideration

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 A holder might have acquired the instrument A holder in due course must have obtained the
Before its maturity or after its maturity Instrument before its due date
A holder may take an instrument with or A holder in due course must have taken the
Without the notice of any defect in the title of Instrument without any notice of defect in the
the transferor title of the transferor
A holder of a negotiable instrument will not A holder in due course will get a better title
Get a better title than that of the transferor Than that of the transferor
A negotiable instrument which passes through A negotiable instrument which passes through
The hands of holder doesn‟t takes its all bad The hands of holder in due course takes its all
aspects. bad aspects

 Crossing of cheque
 Cheques are two types namely open cheques and crossed cheques
 A cheque without crossing is called an open cheque. These are payable at the counter of
the bank to any person who present it
 A crossing is a direction to the paying banker to pay the amount of the cheque only to a
banker and not directly to a person who presents it at the counter
 Crossing of a cheque means drawing across the face of the cheque two parallel
transverse lines with or without the words ―any company‖.
 Crossing can be hand written or stamped
 Types of crossing
1) General crossing
 There must be two parallel transverse lines on the face of the cheque
 The lines are generally drawn on the left hand top corner of the cheque
 The words „and company‟ or its abbreviation may be written in between these lines
 The words such as „not negotiable‟ or „account payee‟ can also be added with a
general crossing
 The paying banker is required to pay the amount of a generally crossed cheque to another
bank and not to the holder.
 Examples of general crossing

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 Special crossing
 Section 124 of the negotiable instrument act 1881 defines a special crossing as ―where
a cheque bears across its face, the addition of the name of a banker, 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‖
 Two parallel transverse lines are not at all essential for a special crossing
 The name of the collecting banker should be specified in the crossing
 The words such as „not negotiable‟ or „account payee‟ can also be added with a
special crossing
 The paying banker is required to pay the amount of a specially crossed cheque to the
banker named in the crossing
 The special crossing makes a cheque safer than generally crossed
 cheque Examples of special crossing

 Difference between general crossing and special crossing

General crossing Special crossing
Two parallel transverse lines are essential in These are not essential in special crossing
General crossing
The words „and company‟ may or may not These words are not written in
be Written in general crossing special Crossing
In general crossing the name of the collecting In special crossing the name of the collecting
Banker is not written on the face of the Banker is written on the face of the cheque

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 Cheque
The amount of the generally crossed cheque The amount of the specially crossed cheque
can be paid to any banker can be paid only to the banker named in the
Crossing
The generally crossed cheque becomes safe Special crossing makes the cheque more
Safer than generally crossing

Not negotiable crossing

 The word „not negotiable‟ may be included in general and special crossing
 Not negotiable means not transferable. It doesn‟t affect the transferability but it only
takes way the negotiability of the cheque
 Negotiability means transferability by mere delivery and endorsement plus
transferability free from defects.
 The cheque crossed „not negotiable‟ can be transferred like any other cheque. But
the transferee will not get better title than that of the transferor. If the title of the
transferor is defective, the title of the transferee will also de defective
 Account payee crossing
 This type of crossing gives further protection to a cheque
 It is a direction to the collecting banker that he should collect the cheque for the
benefit of the payee only and nobody else
 Double crossing
 It is crossing a cheque specially to more than one banker
 A cheque cannot have double or special crossing because the very purpose of the first
crossing is defeated by the second crossing
 Obliterating a crossing
 It means erasing the crossing on the cheque
 Sometimes, the crossing on a cheque is erased by a dishonest person. Such
obliteration may be made so cleverly as to make it difficult for the paying banker to
detect it and consequently he makes the payment of the cheque at the counter
 Opening of crossing
 If the crossing on the cheque is cancelled, it is called the opening of crossing. Then it
becomes an open cheque
 The drawer alone has the right to cancel the crossing

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  He can cancel the crossing by writing the words „pay cash‟ and putting his full
signature.

Demand draft
 it is an instrument used for effecting transfer of money. It is a negotiable instrument
 Section 85 of negotiable instrument act ―a demand draft is an order to pay money drawn
by one office of a bank upon another office of the same bank for a sum of money payable
to order on demand
 The validity period of a demand draft is 3 months, but it can revalidated on application.
 It can never be dishonoured because its payment is done in advance
 A demand draft of rs 20000 or more can be issued only with a/c payee crossing

 Difference between cheque and demand draft

Cheque Draft
It is issued by an individual It is issued by a banker
It is drawn by an account holder of a bank It is drawn by one branch of bank on
another Branch of the same bank
In a cheque drawer and drawee are different In a draft both the drawer and drawee are the
Persons Same bank
It is defined in the negotiable instrument act It has not precisely defined in
negotiable Instrument act
Payment of cheque can stopped by The payment of draft cannot be stopped
the Drawer
Here payment is made after Dd is given after making payment to bank
presenting Cheque to bank,
It is not backed by a bank guarantee Dd are backed by bank guarantees and are,
Therefore more secure
It can be made payable either to bearer It is always payable to order of a
or Order certain Person
It can be dishonoured for want of sufficient Draft cannot be dishonoured
Balance in account

Endorsement

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  It means signing on the back of a negotiable instrument for the purpose of negotiation.
 section 15 of the negotiable instrument act 1881 defines endorsement as follows; “where
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 signs for the same purpose a stamp paper intended to be completed
as a negotiable instrument, he is said to endorse the same, and is called the endorser”
 Endorsement is the act of signing a negotiable instrument by the maker or endorser for the
purpose of negotiation.
 The person who signs the instrument for the purpose of negotiation is called endorser
 The person to whom instrument is endorser is called endorsee.
 The endorser may sign either on the face or on the back of the negotiable instrument.
Generally it is made on the back
 Allonge
 If the entire space on the back of a negotiable instrument is covered with endorsement, a
piece of paper is safely attached to the instrument for the purpose of endorsement. All
subsequent endorsement is made on this piece of paper
 The paper attached with a negotiable instrument for the purpose of making further
endorsement is called ―allonge‖
 Effects of allonge
 After endorsement, the endorsee gets the right, title or property in the instrument
 He also gets the right of further negotiation
 The endorsee acquires the right of the instrument as its holder
 The endorser certifies the genuineness of the instrument
 The endorser, by his act of endorsing, promises to indemnify the endorsee or any
subsequent holder for any loss suffered by them on the dishonour of the
instrument
 The endorser guarantees to the endorsee that he had a good title to the instrument.
 General rules regarding endorsement
 Signature of the endorser
The endorser or any other person who are authorised to endorse has to sign the
instrument to form a valid endorsement.
 Spelling
The endorser should spell his name in the same way as it appears on the instrument
as payee or endorsee

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 Example: if the payees name is wrongly spelt as sitara instead of sithara, regular endorsement
is as follows;
Sd/ sitara
sithara
 No addition or omission of the initial of the name
An initial cannot be added or omitted from the name of the payee or endorsee as
given in the cheque
Example: a cheque payable to k.p sahadevan cannot be endorsed as k. Sahadevan
 Prefixes and suffixes should be avoided
The prefixes and suffixes to the name of the payee or endorsee should be excluded in
the endorsement
Example: a cheque payable to dr. P.t. Sebastian may be endorsed as p.t. Sebastian, m.d
 Endorsement by women
In the case of spinster, the correct endorsement consists of her first name and
surname. That is her endorsement is her maiden name followed by her father‟s name
In the case of married women, she should endorse it in her name plus the name of her
husband
 Endorsement by illiterate person
If the payee of negotiable instrument is an illiterate person, he may endorse the
instrument by affixing his thumb impression thereon, it should be witnessed or attested
by somebody who should give his full address. The proper endorsement is
Thumb impression muneer
Attested by
Sd/ abdul salam, advocate
court road, kozhikode.
 Endorsement by firms
In case of partnership firm, the name of the firm must be signed by a person (partner,
manager etc.) Who is duly authorised to sign on behalf of the partnership firm. The name
of the firm must be mentioned in full. Company may be endorsed in any one of the
following ways
1. „pay to bright company‟

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 For sai trading
company saikumar
(partner or manager)
2. „ pay to krishna traders‟
per pro sai trading company
sai govind
 Endorsement by companies and other institutions
In the case of joint stock companies and other institutions endorsement should be
made by person who is authorised to sign on behalf of the company.
Example: 1. A cheque payable to global trading limited is endorsed as follows;
for global trading limited
Rajeev
(director, manager, secretary or accountant)
2. A cheque payable to jawahar college is endorsed as
follows; for jawahar college
Principal
 Endorsement by agent
A person may authorise his agent to endorse the cheques on his behalf. Endorsement
in such a case should be as follows;
For (or on behalf of or per pro) m. Sreenivasan
K.s ranjith (agent)
 Endorsement by liquidators
If a company is liquidated and an official receiver is appointed. A cheque payable to
him can be endorsed as follows;
For ajith minerals ltd. In liquidation
p.mohandas (liquidator)
 Endorsement by trustees and executors
If a cheque is payable to trustees or executors, it should be endorsed by all of them.
P.kuruvila
R. Laxmanan
(trustees of late joseph mathew)
 Kinds of endorsement
3. Blank endorsement
4. Special endorsement

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 5. Restrictive endorsement
6. Conditional or qualified endorsement
7. Sans resource endorsement
8. Sans frais endorsement
9. facultative endorsement
 Liability of endorser
 By endorsing an instrument, the endorser impliedly promises that on due presentation,
the instrument will be accepted and paid
 In case of dishonour of bill, the endorser will compensate the holder, provided the notice of
dishonour is to be given
 He will not deny to a holder in due course, the genuineness or regularity of a drawers
signature and endorsement
 The endorser will not deny the validity of endorsement and his title to the instrument to
any subsequent endorsee
 Where there are two or more endorsement on an instrument, the liability of the endorser
will be fixed in the order in which their signature appear on the instrument
 The liability of the endorser continues even alter the death till the instrument is paid.
 The liability of endorser can be excluded by a spate contract to the contrary
 When the instrument is paid in due course, the endorser is relieved from his liability
 The ― endorser can get rid of his liability by making such endorsements like ―sans recourse
 Regularity of endorsement
1. Payee or endorsee of a bill himself or his duly authorised agent must sign the endorsement
2. If a cheque is payable to two persons, both of them must endorse in their own handwriting
3. The endorser should not sign in capital letter, otherwise it will be treated as irregular
4. Spelling of the name of endorsee must be the same as appearing in the instrument.
5. Initials of the name of payee or holder should not be changed in the endorsement. All the
prefixes and suffixes should be dropped while endorsing an instrument
6. Endorsement in pencil or by rubber stamp are usually not accepted
7. In the case of a married women, she should endorse the instrument by her name plus the
name of her husband
8. In the case of spinster, the correct endorsement consists of her first name and surname
9. An illiterate person can endorse an instrument by putting his left hand thumb impression
10. A cheque in the name of a deceased person must be endorsed by his legal representative

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11. Endorsements in the case of firms can be either in the name itself or it may be authorised
by an agent or by legally authorized person on behalf of the firm
12. A cheque payable to executors and administrators may be endorsed by all of them or any
one of them acting for all.

Marking of cheques

 It is a sort certification given to the cheque by the paying banker.

 Marking is done by the drawee bank by stamping across the cheque ―good for
payment‖ by marking the drawee bank under takes the obligation to pay the cheque.
 It gives an additional guarantee to the cheque.
 The drawee bank may certify a cheque when there is sufficient balance in the account
of the drawer
 Marking of cheques can be done at the following instances
1. Marking at the request of the drawer
2. Marking at the request of the payee or any holder
3. Marking at the request of another banker
 The certifying bank can cancel the marking of cheque at any time, before the cheque is
delivered by the drawer to the payee

Electronic payments

 It is a subset of an e-commerce transaction to include electronic payment for buying and

selling goods or services offered through the internet
 These are payments that are made directly to payee from our bank accounts using
security features over the internet to process the transactions
 Electronic payment is a financial exchange that takes place online between buyers and
sellers
 The content of this exchange is usually some form of digital financial instrument that is
backed by a bank or an intermediary, or by a legal tender
 The various factors that have lead the financial institutions to make use of electronic
payments are;
1. Decreasing technology cost
2. Reduced operational and processing cost
3. Increasing online commerce

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  Parties of e- payments
 It involve a payer and payee. A payer (buyer, customer), is an entity who makes a
payment. A payee (seller, merchant), is an entity who receives a payment. The process is
also involves a financial institution ( bank or mint)
 typically, financial institution participates in payment protocols in two roles; as an issuer
(interacting with the payer) and as an acquirer (interacting with the payee).
 The issuer is responsible for validating the payer during account registrations and holds
the payer‟s account and assets. The acquirer holds the payee‟s accounts and assets.
 The payee deposits the payments received during a transaction with the acquirer. The
acquirer and the issuer then proceed to perform an inter-banking transaction for clearance
of funds. It is possible for the issuer and the acquirer to be from the same financial
institution.
 Other parties that may be present in a payment protocol include a trustee (arbiter) who is
an entity that is independent from all parties.
 All entities in a protocol unconditionally trust the trustee who is called to adjudicate any
disputes between the payer and the payee
 Characteristics of e-payments
• There is no paper
 Fast, safe, efficient, secure and generally less costly than paper based alternatives
 Fully traceable
 Most banks offer same day value for payments made to other accounts held in that
same bank
 Many banks offer same day money transfer inter- bank services for large value payments
 Convenient
 Help business to improve customer retention
 Unlike cheques, electronic payments don‟t „bounce‟ –as payments will not be
effected unless the funds are available in the first place
 Phases in e –payments
1. Registration
2. Invoicing
3. Payment selection and processing
4. Payment authorisation and confirmation
 Types of e-payment

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 Cards
 Internet
 Mobile payments
 Financial service kiosks
 television set-top boxes and satellite receiver
 Biometric payments
 Electronic payments networks
 Person –to-person (p2p) payments.

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