Negotiable Instruments

Negotiable instruments are signed documents that promise a specific sum of payment to a designated person or their assignee. These documents facilitate payments and can be transferred from one person to another multiple times before the final payment is made.

Legal Framework in India

In India, the Negotiable Instruments Act of 1881 governs negotiable instruments. According to Section 13 of this act, a negotiable instrument is defined as “a promissory note, bill of exchange, or cheque, payable either to order or to the bearer.” The act comprises 147 sections, with key sections including Section 4 (Promissory Notes), Section 5 (Bill of Exchange), Section 6 (Cheque), and Section 15 (Endorsements).

Types of Negotiable Instruments

There are three primary types of negotiable instruments:

1. Promissory Note: A written promise by one person (the maker) to pay a specified sum of money to another person (the payee) at a specified future date.

2. Bill of Exchange: A written order by one person (the drawer) to another person (the drawee) to pay a specified sum of money to a third person (the payee) at a specified future date.

3. Cheque: A written order by one person (the drawer) to a bank (the drawee) to pay a specified sum of money to a third person (the payee) on demand.

Significance in Banking Exams

Competitive banking exams, such as the IBPS PO, SBI PO, and SBI Clerk, place significant emphasis on negotiable instruments. Candidates should thoroughly understand the concepts related to negotiable instruments, including their types, legal provisions, and practical applications, to excel in these exams.

Negotiable instruments play a vital role in facilitating payments and credit transactions in the modern business world. Understanding their legal framework and practical applications is crucial for individuals aspiring to succeed in banking and finance careers.

Features of Negotiable Instruments

As per the definitions, negotiable instruments must possess the following characteristics:

Easily Transferable:

• Negotiable instruments should be easily and freely transferable.
• No formalities or extensive paperwork are required for transferring ownership.
• Ownership can be transferred simply by delivery or valid endorsement.

Must be in Writing:

• Negotiable instruments must be in writing, including handwritten notes, printed, engraved, or typed formats.

Time of Payment must be Certain:

• An instrument is not considered negotiable if the time of payment is uncertain.
• It must be payable within a specific period or on a specific date.

Payee must be Certain:

• The payee (the person to whom the instrument is payable) must be clearly specified and identifiable.

Negotiable Instruments: Requirements and Payees

Payees

• The person or persons to whom a negotiable instrument is made payable must be specific and identifiable.
• There can be more than one payee for a negotiable instrument.
• The term “person” includes artificial persons such as body corporates, trade unions, shareholders, secretaries, etc.

Requirements

A negotiable instrument must meet the following requirements:

• It must be in written form.
• It must contain an unconditional promise or order to pay a specified sum of money, with or without interest.
• The payment must be made after a set time or on demand.
• The instrument must be payable to the bearer or to order.
• It must not require the person promising payment to perform any other action other than payment.

Importance of Negotiable Instruments

Negotiable instruments hold significant importance in the commercial world, particularly with the growth of international trade.

• Property Rights: Negotiable instruments represent complete ownership and property rights.

• Transferability: They can be easily transferred from one person to another without extensive formalities, making them widely used in business transactions.

Transfer of Negotiable Instruments

• Transfer can be done through endorsement or delivery, which is common in business transactions.
• Payments made through instruments are immediate, minimizing loss of time.

Advantages of Negotiable Instruments

• In a negotiable instrument, the consideration between the debtor and creditor is presumed. So the purchaser is in-depth with the seller, and the seller needs not to prove this fact.
• The creditor does not have to wait for the maturity period to get the money. They can immediately opt for the bill, discounting the bill to a creditor of their own.
• Accommodation bills enable the businessman to obtain funds at a lower rate of interest as there may arise a shortfall from time in business.

Promissory Note and Cheque

Promissory Note

At maturity, the issuer of the promissory note makes a full payment directly to the bank. The bank’s profit is the difference between the note’s face value and the amount paid to the payee.

Parties to a Promissory Note

• Maker or Drawer: The person who creates the note and promises to pay the specified amount.
• Payee: The person to whom the amount is payable.

Cheque

Cheques are negotiable instruments commonly used in daily business transactions for making payments. They are widely accepted by businesses and individuals. A cheque transaction involves three parties.

Parties to a Cheque

• Drawer: The party issuing the cheque and maintaining an account with the bank.
• Drawee: The party directed to make the payment, typically the bank.
• Payee: The party receiving the payment made by the drawee. If the drawer draws the cheque in their own favor, they become the payee.

The cheque serves as a written order from the drawer to the drawee to pay the payee the specified amount. The drawer’s account is debited accordingly. Banks earn a nominal fee by providing checkbooks to customers.

Types of Cheques

• Bearer Cheque: When the word “Bearer” on the cheque is not crossed or canceled, it is called a bearer cheque. These cheques are payable to the person specified in the instrument or any individual who possesses it and presents it for payment over the counter.
• Order Cheque: When the word “Bearer” on a cheque is crossed or canceled, it becomes an order cheque. It is payable only to the specified person named in the cheque or any other person to whom it is endorsed.
• Crossed or Account Payee Cheque: The issuer of the cheque specifies it as an account payee by drawing two parallel lines on the top left middle or right-hand corner of the cheque. This type of cheque cannot be encashed over the counter.
• Anti-Dated Cheque: A cheque bearing a date earlier than the date of presentation for payment is known as an anti-dated cheque.
• Post-Dated Cheque: A cheque bearing a date in the future is called a post-dated cheque.
• Stale Cheque: A cheque becomes stale after three months from the date written on it and cannot be honored by the bank.
• Mutilated Cheque: When a cheque is torn into two or more pieces and presented for payment at the bank, it is called a mutilated cheque.

Endorsements

• According to Section 15 of the Negotiable Instruments Act 1881, an “Endorsement” occurs when the maker or holder of a negotiable instrument signs it, other than as the maker, for the purpose of negotiation on the back or face of the instrument or on an attached slip of paper. By doing so, the person is said to endorse the instrument and is referred to as the “endorser.”
• Endorsement involves transferring a document or instrument to another person by signing on its back, face, or on a slip of paper attached to it.
• Endorsement serves as a method of negotiating a negotiable instrument.
• A negotiable instrument payable to someone other than the bearer can only be negotiated through endorsement and delivery.

Endorsement of Negotiable Instruments

The act of a person who holds a negotiable instrument signing their name on the back of that instrument, thereby transferring title or ownership in an endorsement. It may be in favor of another individual or legal entity.

Types of Endorsements

1. Bank Endorsement

• The endorser becomes payable to the bearer, meaning they sign their name only.

2. Special Endorsement

• The endorser signs and writes the name of the person who will receive the payment.

3. Restrictive Endorsement

• Restricts further negotiations.

4. Partial Endorsement

• Allows transferring only a part of the amount payable on the instrument to the endorsee.

5. Conditional Endorsement

• Requires the fulfillment of some conditions.

Negotiable Instruments FAQs

What is a negotiable instrument?

• Signed documents that promise a particular sum of payment to a specified person or the assignee.

What are the types of negotiable instruments?

• Bills of Exchange, Cheque, Endorsements, and Promissory notes.