INTRODUCTION

In India, there is reason to believe that instrument to exchange were in use

from early times and we find that papers representing money were

introducing into the country by one of the Mohammedan sovereigns of Delhi

in the early part of the fourteenth century. The word 'hundi', a generic term

used to denote instruments of exchange in vernacular is derived from the

Sanskrit root 'hund' meaning 'to   collect' and well expresses the purpose to

which instruments were utilized in their origin. With the advent of British

rule in India commercial activities increased to a great extent. The growing

demands for money could not be met be mere supply of coins; and the

instrument of credit took the function of money which they represented.

Before the enactment of the Negotiable Instrument Act, 1881, the law of

negotiable instruments as prevalent in England was applied by the Courts in

India when any question relating to such instruments arose between

Europeans. When then parties were Hindu or Mohammedans, their personal

law was held to apply. Though neither the law books of Hindu nor those of

Mohammedans contain any reference to negotiable instruments as such, the

customs prevailing among the merchants of the respective community were

recognized by the courts and applied to the transactions among them. During

the course of time there had developed in the country a strong body of usage

relating to hundis, which even the Legislature could not without hardship to

Indian bankers and merchants ignore. In fact, the Legislature felt the strength

of such local usages and though fit to exempt them from the operation of the

Act with a proviso that such usage may be excluded altogether by

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appropriate words. In the absence of any such customary law, the principles

derived from English law were applied to the Indians as rules of

equity justice and good conscience.

The history of the present Act is a long one. The Act was originally drafted

in 1866 by the India Law Commission and introduced in December, 1867 in

the Council and it was referred to a Select Committee. Objections were

raised by the mercantile community to the numerous deviations from the

English Law which it contained. The Bill had to be redrafted in 1877. After

the lapse of a sufficient period for criticism by the Local Governments,  the

High Courts and the chambers of commerce, the Bill was revised by a Select

Committee. In spite of this Bill could not reach the final stage. In 1880 by

the Order of the Secretary of State, the Bill had to be referred to a new Law

Commission. On the recommendation of the new Law Commission the Bill

was re-drafted and again it was sent to a Select Committee which adopted

most of the additions recommended by the new Law Commission. The draft

thus prepared for the fourth time was introduced in the Council and was

passed into law in 1881 being the Negotiable Instruments Act, 1881 (26 of

1881)

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Differences from a contract:

A negotiable instrument is not a contract, as contract formation requires an

offer, acceptance, and consideration, none of which is an element of a

negotiable instrument. Unlike ordinary contract documents, the right to the

performance of a negotiable instrument are linked to the possession of the

document itself (with certain exceptions such as loss or theft).The rights of

the payee (or holder in due course) are better than those provided by

ordinary contracts as follows:

The rights to payment are not subject to set-off, and do not rely on the

validity of the underlying contract giving rise to the debt (for example if a

cheque was drawn for payment for goods delivered but defective, the drawer

is still liable on the cheque).

No notice needs to be given to any prior party liable on the instrument for

transfer of the rights under the instrument by negotiation.

Transfer free of equities—the holder in due course can hold better title than

the party he obtains it from.

Negotiation enables the transferee to become the party to the contract, and to

enforce the contract in his own name. Negotiation can be effected by

endorsement and delivery (order instruments), or by delivery alone (bearer

instruments). In addition, it includes the rule of a derivative title which does

not allow a property owner to transfer rights in a piece of property greater

than his own.

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Usage:

While bearer instruments are rarely created as such, a holder of commercial

paper with the holder designated as payee can change the instrument to a

bearer instrument by an endorsement. The proper holder simply signs the

back of the instrument and the instrument becomes bearer paper, although in

recent years, third party checks are not being honored by most banks unless

the original payee has signed a notarized document stating such.

Alternately, an individual or company may write a check payable to "Cash"

or "Bearer" and create a bearer instrument. Great care should be taken with

the security of the instrument, as it is legally almost as good as cash.

Exceptions:

Under the Code, the following are not negotiable instruments, although the

law governing obligations with respect to such items may be similar to or

derived from the law applicable to negotiable instruments:

Letters of credit, which are governed by Article 5 of the Code.

Bills of lading and other documents of title, which are governed by Article 7

of the Code.

Securities, such as stocks and bonds, which are governed by Article 8 of the

Code.

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Deeds and other documents conveying interests in real estate, although a

mortgage may secure a promissory note which is governed by Article 3 of

the Code.

Definition of Negotiable Instrument:

"Negotiable instrument":-

(1) A "negotiable instrument" means a promissory note, bill of

exchange or cheque payable either to order or to bearer.

Explanation (i):-promissory note, bill of exchange or cheque is payable

to order which is expressed to be so payable to a particular person, and

does not contain words prohibiting transfer or indicating an intention

that it shall not be transferable.

Explanation (ii):-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 endorsements is an endorsement is an endorsement in blank.

Explanation (iii):-here a promissory note, bill of exchange or cheque,

either originally or by endorsement, is expressed to be payable to the

order of a specified person, and not to him or his order, it is

nevertheless payable to him or his order at his option.

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(2) A negotiable instrument may be made payable to two or more

payees jointly, or it may be made payable in the alternative to one or

two, or one or some of several payees.

CHARACTERISTIC OF A NEGOTIABLE INSTRUMENT:

A negotiable instrument has the following characteristics:

1) PROPERTY: The possessor of the instrument is the holder and owner

thereof. A negotiable instrument does not merely give possession of the

instrument, but right to property. Whosever gets possession of the

instrument becomes its owner and is entitled to the sum mentioned therein as

the holder. It passes by mere delivery where instrument is payable to

‘bearer.’

2) DEFECTS IN TITLE: The holder in good faith and for value called the

‘holder in due course’ gets the instrument free from all defects of any

previous holder.

3) REMEDY: The holder can sue upon the negotiable instrument in his own

name. All prior parties are liable to him. A holder in due course can recover

the full amount of the instrument.

4) RIGHT: The holder in due course is not affected by certain defenses

which might be available against previous holder, for example, fraud, to

which he is not a party.

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5) PAYABLE TO ORDER: All three negotiable instruments are payable to

order which is expressed to a particular person. An instrument which does

not restrict its transferability expressly is negotiable whether the word

‘order’ is mentioned or not. The word ‘order’ or ‘bearer’ is no longer

necessary to render an instrument negotiable.

It must be noted that the entire three negotiable instrument is endorsed and is

expressed to be payable to the order of a specified person, it is nevertheless

payable to him or his order.

6) PAYABLE TO BEARER: the three negotiable instrument is expressed to

be payable or on which the only or last endorsement is an endorsement in

blank. It specifies that the person in possession of the bill is a bearer of the

instrument which is so expressed payable to bearer.

7) PAYMENT: A negotiable instrument may be made payable to two or

more payees, or it may be payable in alternative to one or two payees.

8) CONSIDERATION: Consideration in the case of a negotiable instrument

is presumed.

9) PRESUMPTIONS: Certain presumptions apply to all negotiable

instruments.

PROMISSORY NOTE

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A written document in which a borrower agrees (promises) to pay back

money to a lender according to specified terms. A written promise to pay a

certain sum of money, at a future time, unconditionally.

A promissory note differs from a mere acknowledgment of debt, without any

promise to pay, as when the debtor gives his creditor an I 0 U. In its form it

usually contains a promise to pay, at a time therein expressed, a sum of

money to a certain person therein named, or to his order, for value received.

It is dated and signed by the maker. It is never under seal. He who makes the

promise is called the maker, and he to whom it is made is the payee.

Although a promissory note, in its original shape, bears no resemblance to a

bill of exchange; yet, when indorsed, it is exactly similar to one; for then it is

an order by the endorser of the note upon the maker to pay to the endorsee.

The endorser is as it were the drawer; the maker, the acceptor; and the

endorsee, the payee.

Most of the rules applicable to bills of exchange, equally affect promissory

notes. No particular form is requisite to these instruments; a promise to

deliver the money, or to be accountable for it, or that the payee shall have it,

is sufficient.

There are two principal qualities essential to the validity of a note; first, that

it be payable at all events, not dependent on any contingency nor payable out

of any particular fund. And, secondly, it is required that it be for the payment

of money only and not in bank notes.

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Illustrations

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

(b) "I acknowledge myself to be indebted to B in Rs. 1, 000, to be paid on

demand, for value received."

The terms of a note typically include the principal amount, the interest rate if

any, and the maturity date. Sometimes, provisions are included concerning

the payee's rights in the event of a default, which may include foreclosure of

the maker's assets. Demand promissory notes are notes that do not carry a

specific maturity date, but are due on demand of the lender. Usually the

lender will only give the borrower a few days notice before the payment is

due. For loans between individuals, writing and signing a promissory note

are often instrumental for tax and record keeping. In the United States, a

promissory note that meets certain conditions is a negotiable instrument

regulated by article 3 of the Uniform Commercial Code. Negotiable

promissory notes are used extensively in combination with mortgages in the

financing of real estate transactions. Promissory notes, or commercial

papers, are also issued to provide capital to businesses.

Historically, promissory notes have acted as a form of privately issued

currency. In many jurisdictions today, bearer negotiable promissory notes

are illegal because they can act as an alternative currency.

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SAMPLE PROMISSORY NOTE

This document is to be used as a guideline only. How Stuff Works does not

guarantee that this document is suitable, or legally accurate, for all

situations, and is not liable for any deficiencies in the document’s content.

Borrower Information:

Name: Date:

Street Address: Date of Birth:

City: Area code/Telephone number:

State: Driver’s License Number:

Zip: Social Security Number:

Lender Information:

Name: Area code/Telephone number:

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Street Address: If paying by check, make check

payable to:

Send payments to:

City:

State:

Zip:

Loan Information:

Loan Amount: Loan Period:

Interest Rate: Payment Schedule:

1. Promise to Pay: For value received, ____________________ (Borrower)

promises to pay ____________________ (Lender) $___________ and

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interest at the yearly rate of _____% on the unpaid balance as specified

below.

2. Installments:

Borrower will pay ______ payments of $_____ each at

monthly/yearly/_________ intervals on the _____ day of the month.

Borrower will pay one lump payment on ______________ date.

Borrower will pay ______ payments of $_____ each at

monthly/yearly/_________ intervals with a final balloon payment of

____________ at the end of the loan term on _________ date.

3. Application of Payments: Payments will be applied first to interest and

then to principal.

4. Prepayment: Borrower may prepay all or any part of the principal

without penalty.

5. Loan Acceleration: If Borrower is more than _______ days late in

making any payment, Lender may declare that the entire balance of unpaid

principal is due immediately, together with the interest that has accrued.

6. Security:

This is an unsecured note.

Borrower agrees that until the principal and interest owed under this

promissory note are paid in full, this note will be secured by a security

agreement and Uniform Commercial Code Financing statement giving

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Lender a security interest in the equipment, fixtures, and inventory

and accounts receivable of the business.

7. Collection Costs: If Lender prevails in a lawsuit to collect on this note,

Borrower will pay Lender's costs and lawyer's fees in an amount the court

finds to be reasonable.

The undersigned and all other parties to this note, whether as endorsers,

guarantors or sureties, agree to remain fully bound until this note shall be

fully paid and waive demand, presentment and protest and all notices hereto

and further agree to remain bound notwithstanding any extension,

modification, waiver, or other indulgence or discharge or release of any

obligor hereunder or exchange, substitution, or release of any collateral

granted as security for this note. No modification or indulgence by any

holder hereof shall be binding unless in writing; and any indulgence on any

one occasion shall not be an indulgence for any other or future occasion.

Any modification or change in terms, hereunder granted by any holder

hereof, shall be valid and binding upon each of the undersigned,

notwithstanding the acknowledgement of any of the undersigned, and each

of the undersigned does hereby irrevocably grant to each of the others a

power of attorney to enter into any such modification on their behalf. The

rights of any holder hereof shall be cumulative and not necessarily

successive.

Witnessed: __________ Date: ____________

Witnessed: __________ Date: ____________

Borrower: ___________ Date: ____________

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Borrower: ___________ Date: ____________

ELEMENTS OF A PROMISSORY NOTE

WRITING: The promissory note must be in writing. Oral

engagement or promise is excluded. No particular form of

words is necessary. It may be in any form but the words shall

be visible. Intention to make a note must be clear.

UNDERTAKING TO PAY: It is not necessary to use the word

“promise” but the intention must clearly show an

‘unconditional undertaking’ to pay the amount. The word

‘promise’ does not mean that a document is not a promissory

note, provided it fulfils the requirements of this section and

there is clear intention on the part of the parties to treat the

document as a promissory note.

ILLUSTRATIONS:

a) “I acknowledge to pay on demand Rs 1000 for value received.”

But –“I acknowledge receipt of Rs 1000” is not a Promissory note.

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b) “I promise to pay B Rs 1000 on demand.” It is a Promissory note.

c) “I owe you Rs1000” this not a promissory note.

UNCONDITIONAL: It must contain definite and an

unconditional undertaking to pay. Promise to pay should be

unconditional. A conditional instrument is invalid. It must be

certain of payment.

ILLUSTRATIONS:

Conditional promissory note:

a) “I promise to pay B Rs1000 7 days after C’s marriage.”

b) “I promise to pay B Rs1000 after deducting a sum due to him.”

These writing are conditional. Payment is subjected to a certain event

happening or not happening. Such writing are not promissory notes.

Unconditional promissory note:

a) A promise given for an executed consideration.

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b) Any promise to pay an instrument on lapse of certain periods, after

a specified event which is certain to happen.

Valid conditional promissory note:

a) “I promise to pay B Rs500, 3 days after the death of X.

This is a valid promissory note as death is a certain event to happen;

though time of death is uncertain.

b) “I promise to pay B Rs500 at Bombay.”

SIGNED: The instrument must be signed by the maker thereof.

Person must sign with his consent. It should not only be a

physical act but also a mental act with an intention to sign.

CERTAIN PERSON: The maker and payee of the instrument

must be a definite person. A note may be made by several

people to bind them jointly. A promissory note cannot be made

by two persons. Two different people should fill in the role of a

maker and payee. The maker endorses the note. Payee is

capable of being ascertained where he is wrongly described, he

will be a certain person.

E.g. - a promissory note payable to “my only niece living in England”

is a valid promissory note.

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SPECIFIC SUM: The sum promise to be paid must be specific.

ILLUSTRATIONS:

“I promise to pay B Rs 300 and all other sums due to him.”

However, payment of a note with interest does not invalidate a

promissory note. Interest rate may or may not be specified.

PROMISE TO PAY MONEY ONLY: The promise to pay must

be money only. Promise to pay anything other than legal tender,

in full or in part, is not a promissory note.

ILLUSTRATIONS:

a) “I promise to pay B Rs. 100 in cash and Rs. 100 worth of

cosmetics.”

b) “I promise to pay B Rs. 500 and to deliver him my black horse.”

c) “I promise to pay B Rs. 500 in government Bonds.”

These are all invalid promissory notes.

STAMPING: Promissory notes are chargeable with stamp duty.

It is advisable to cancel the stamps with maker’s signature or

initials. An unstamped or improperly or insufficiently stamped

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promissory note is not valid as evidence in court of law. No suit

can be maintained upon an unstamped or improperly stamped

promissory note.

Case Study:

An IT company is developing a specialized IT platform for a customer.

Work commenced 1 January 2005. At 31 December 2005, the hardware

(which the IT Company also sells separately) has been installed and the

software is 50% completed.

 

The IT Company does not anticipate any problem with the software

development, which should take another 6 months to complete. The

customer has the right to return the hardware if the software does not work

according to the customer’s specifications.

 The contract as a whole is approximately 70% completed based on the costs

incurred, which is a reliable measure of the services performed.

   

Costs incurred to date and costs to complete can be measured reliably for the

hardware and software separately and in total. The hardware and software

account for 30% and 70% of the total consideration respectively.

 

Q. Which revenue recognition guidance should be applied to this

transaction?

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   A. Hardware: Sale of goods, Software: Rendering of services

   B. Hardware and software: Rendering of services

   C. Hardware and software: Construction contract

Ans:

C. Hardware and software: Construction contract

   The contract for the construction of the IT platform meets the IAS

11definition of a construction contract: “A contract specifically negotiated

for the construction of an asset or a combination of assets that are closely

interrelated or interdependent in terms of their design, technology and

function or their ultimate purpose or use.”

   Revenue should be recognized using the percentage of completion method

BILL OF EXCHANGE

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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.

A promise or order to pay is not "conditional", within the meaning of this

section and section 4, by reason of the time for payment of the amount or

any installment thereof being expressed to be on the lapse of certain period

after the occurrence of a specified event which, according to the ordinary

expectation of mankind, is certain to happen, although the time of its

happening may be uncertain.

The sum payable may be "certain", within the meaning of this section and

section and section4, although it includes future indicated rater of change, or

is according to the course of exchange, or is according to the course of

exchange, and although the instrument provides that, on default of payment

of an installment, the balance unpaid shall become due.

The person to whom it is clear that the direction is given or that payment is

to be made may be a "certain person," within the meaning of this section and

section 4, although he is misnamed or designated by description only.

ESSENTIAL ELEMENTS OF A BILL OF EXCHANGE

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WRITING: - A bill of exchange must be in writing and may be in any

language, and in any form.

PARTIES: - There must be three parties to a bill of exchange, i.e.,

Drawer, Drawee and Payee.

PAYEE: - Payee as the person named in the instrument, to whom or to

whose order the money, by the instrument directed to be paid.

ORDER TO PAY: - The bill of exchange must contain an order by the

drawer to the drawee to pay under any circumstances.

UNCONDITIONAL: - The 0rder in the bill must be unconditional, for

example, payable under all events and circumstances. Conditional bill

is invalid.

SIGNED: - The bill must be signed by the drawer.

MONEY:- The order must be to pay money only

PAYEE MUST BE CERTAIN: - Bill may be made payable to two or

more payees jointly or in the alternatives.

CERTAIN SUM: - The sum payable may be ‘certain’ although it

includes future interest or is payable at an indicated rate of exchange,

or is according to the course of exchange.

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STAMPING: - Bill of exchange is chargeable with stamp duty.

Legislation for Bills of Exchange:

Most countries have adopted codified laws on Bills of Exchange. The legal

codes in such countries have created laws that follow the rules agreed at the

Geneva Conventions in order to standardize the control of Bills of

Exchange. The United Kingdom Bills of Exchange Act 1882 is the basis for

rules governing Bills of Exchange in Ireland, U.K. and Commonwealth

countries that were part of the British Empire. These countries follow a

common law framework to create and modify statutes.

In relation to the most fundamental aspects of a Bill of Exchange the two

sets of rules are similar in that both identify the following:

A bill of exchange is an unconditional order to pay a specific amount

of money.

The bill of exchange must state a particular time of payment.

The bill of exchange must contain the name of the person who is to

pay.

There are, however, certain differences between the Bills of Exchange Act

(1882) and the Geneva Convention. In particular the United Kingdom Act

sets out fewer formal requirements for example:

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The term "Bill of Exchange", which is an integral part of the physical

Bill according to the Geneva Convention, need not be written on the

Bill.

Bills can be made payable to 'bearer'.

The place and date of issue are also not obligatory parts of the Bill.

The United Nations Commission on International Trade Law (UNCITRAL)

is at present trying to harmonize laws through the "United Nations

Convention on International Bills of Exchange and International Promissory

notes".

The function of the Bill of Exchange in International Trade:

The bill of exchange performs many functions in international trade

including:

Facilitates the granting of trade credit in a legal format by permitting

payments on agreed future dates.

Provides formal evidence of the demand for payment from a seller to

a buyer.

Provides the seller with access to finance by permitting them to

transfer their debts to a bank or other financier by merely endorsing

the Bill of Exchange to that bank or financier.

Permits the banker or financier to retain a valid legal claim on both

the buyer and the seller. In certain circumstances a bank or financier

may have a stronger legal claim under a Bill than the party that sold

them the debt.

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Permits a seller to obtain greater security over the payment by

enabling a bank to guarantee a drawee's acceptance (guarantee to pay

on the due date) by signing or endorsing the Bill. (See Guaranteed

Bills of Exchange below)

Allows a seller protect their access to the legal system in the event of

problems, while providing easier access to that legal system.

How the bill of exchange is used in international trade:

A bill of exchange can either be payable immediately or at some future date.

If a Bill is payable immediately, it is usually issued payable at sight.

The term "at sight" means that a buyer should pay once they have

sighted the Bill that is once the demand for payment has been made.

If a Bill is payable at some future date, it must facilitate the

calculation of the actual due date. For example Bills of Exchange may

be drawn payable at 60 days sight, at 60 days from Bill of Lading

Date etc.

Banks should be used as agents for the collection of the Bill. Visit our

section on Documentary Collections in the Products and Services or Product

Diagrams area of this website for further details.

Guaranteed Bills of Exchange:

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To provide greater payment security a seller may look to have a bill of

exchange guaranteed by a buyer's bank. A guaranteed bill of exchange is one

drawn on and accepted by the buyer and to which, the buyer's bank has

added its guarantee that the Bill will be paid at maturity. The security to a

seller comes from a bank giving an undertaking to effect payment on a

certain date regardless of the financial standing of a buyer on that date.

Financing Options with Bills of Exchange

The ability to negotiate or discount Bills of Exchange can be an extremely

important source of finance in international trade. The bill of exchange can

provide easier access to financing because it enables the financing bank to

retain a claim on all parties to the Bill. In addition parties that finance Bills

of Exchange can, in certain circumstances, obtain stronger rights than the

party transferring the Bill to them. Bill discounting may provide access to

finance rates lower than the overdraft or loan rate the seller could normally

obtain.

Negotiation Facilities:

The negotiation of a Bill is the transfer of the rights under a Bill from one

party to another for value. Some banks will negotiate Bills for a customer by

purchasing Bills from them for value. For example, the bank will advance

75% of the face value of the Bill and upon receipt of the proceeds will clear

the advance together with any accrued interest on the advance. Negotiation

facilities can be used to finance Bills payable at sight or Bills payable at a

future date even before they have been accepted. Negotiation facilities are

normally granted with full recourse to the seller.

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Bills Discounting with recourse:

Discounting of a bill of exchange can only occur once the Bill has a definite

maturity date in the future and the buyer has accepted it. Discounting differs

from negotiation in that the bank will calculate the net present value of the

face value of the Bill utilizing a cost of funds interest rate and a margin. The

net amount so calculated is then advanced to the seller. Upon receipt of the

proceeds from the buyer at maturity, the bank will clear its Bills discounted

account. This finance is provided with recourse to the seller by the bank.

Bills Discounting without recourse:

Similar to with recourse Bills Discounting, except that the financing bank

will waive its rights of recourse to the seller. This can occur when the Bill is

guaranteed by another bank, or where the buyer has a very strong credit

standing or rating.

Advantages of Bills of Exchange:

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Companies have used Bills of Exchange for hundreds of years. Their

longevity is due to the advantages they provide in a trading transaction.

A bill of exchange facilitates the granting of trade credit to a buyer.

A bill of exchange provides a legal acknowledgement that a debt

exists.

It can provide the seller with access to financing.

It can provide easy access to the legal systems in the event of non-

payment.

Legal Protection afforded by Bills of Exchange:

An advantage for a seller in using a bill of exchange is the capability of the

bill of exchange to provide formal documentary evidence that the demand

for payment or acceptance has been made to the buyer. In addition, it may be

possible to sue the buyer for non-payment based solely on this documentary

evidence. A seller can protect their interests by requesting that a bill of

exchange be noted or protested for non-payment or non-acceptance. When a

Bill is not paid or accepted it is said to have been "dishonoured".

Noting:

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A Bill is noted in order to obtain official evidence that it has been

dishonoured. A Notary Public re-presents the Bill to the drawee for

acceptance or payment and minutes on the Bill the reason given for

dishonour. Noting is often followed by a formal protest.

Protesting:

Protesting is a more formal process than noting and results in the production

by the Notary Public of a formal deed of protest bearing a notary's seal. This

document again provides formal evidence of the presentation of the Bill to

the drawee and the reason for dishonour. The protest is accepted by most

courts in the world as evidence that a Bill has been dishonoured.

HUNDI:-

Bills of exchange drawn in vernacular language called ‘hundis’ are covered

by the Act. The word 'hundi', a generic term used to denote instruments of

exchange in vernacular is derived from the Sanskrit root 'hundi' meaning 'to

collect' and well expresses the purpose to which instruments were utilized in

their origin. The Act does not affect any local usage relating to any

instrument in an oriental language. In the absence of any custom or usage

governing such instruments, provisions of the Act will be extended to such

other instruments, for example, hundis, bills of landing, railway receipt, etc.

The act does not affect the transfer of instruments under ordinary law

otherwise than by negotiation, for e.g. by assignment. A bonafide transferee

of a negotiable instrument for value, without notice of any defect acquires

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the instrument free of any defects. He acquires a better title than that of the

transferor irrespective of the transferor’s title being defective.

HOW PROMISSORY NOTE BECOMES A BILL OF EXCHANGE?

An instrument which is a promissory note may become a bill of exchange if

acceptance is endorsed thereon by a third party.

BILLS IN SETS

Bills of exchange may be drawn in parts. All the parts together make a set,

but the whole set constitutes only one bill. Bills are sometimes drawn in

several parts. All the parts so drawn are referred as bill ‘drawn in sets’. The

drawer of the ‘bills in sets’ has to sign all the parts and deliver all the parts

but the acceptance should be written only on one part. If the drawee accepts

more than one part and if such separate accepted parts get into the hands of

different holders in due course, he and the subsequent endorsers of each part

are liable on every such part as if it were a separate bill.

CHEQUE

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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 I.-For the purposes of this section, the expressions-

(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 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 the cheque in writing.

Explanation II.-For the purposes of this section, the expression "clearing

house" means the clearing house managed by the Reserve Bank of India or a

clearing house recognized as such by the Reserve Bank of India.

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Cheques generally contain:

1. Place of issue

2. Cheque number

3. Date of issue

4. Payee

5. Amount of currency

6. Signature of the drawer

7. Routing / account number in MICR format - in the U.S., the routing

number is a nine-digit number in which the first 4 digits identifies the U.S.

Federal Reserve Bank's cheque-processing center. This is followed by digits

5 through 8, identifying the specific bank served by that cheque-processing

center. Digit 9 is a verification digit, computed using a complex algorithm of

the previous 8 digits. The account number is assigned independently by the

various banks.

8. Fractional routing number (U.S. only) - also known as the transit number,

consists of a denominator mirroring the first 4 digits of the routing number.

And a hyphenated numerator, also known as the ABA number, in which the

first part is a city code (1-49), if the account is in one of 49 specific cities, or

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a state code (50-99) if it is not in one of those specific cities; the second part

of the hyphenated numerator mirrors the 5th through 8th digits of the routing

number with leading zeros removed.

A cheque is generally valid indefinitely or for six months after the date of

issue unless otherwise indicated; this varies depending on where the cheque

is drawn [citation needed]. In Australia, for example, it is fifteen months In

the United States; it is six months Legal amount (amount in words) is also

highly recommended but not strictly required.

In the USA and some other countries, Cheques contain a memo line where

the purpose of the cheque can be indicated as a convenience without

affecting the official parts of the cheque. This is not used in Britain where

such notes are often written on the reverse side.

In the USA, at the top (when cheque oriented vertically) of the reverse side

of the cheque, there are usually one or more blank lines labeled something

like "Endorse here".

Types of Cheques in the United States:

In the United States, cheques are governed by Article 3 of the Uniform

Commercial Code. An order check — the most common form in the United

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States — is payable only to the named payee or his or her endorsee, as it

usually contains the language "Pay to the order of (name)."

A bearer check is payable to anyone who is in possession of the document:

this would be the case if the cheque does not state a payee, or is payable to

"bearer" or to "cash" or "to the order of cash", or if the cheque is payable to

someone who is not a person or legal entity, e.g. if the payee line is marked

"Happy Birthday".

Parties to regular cheques generally include a maker, the depositor writing a

cheque; a drawee, the financial institution where the cheque can be

presented for payment; and a payee, the entity to whom the maker issues the

cheque. Ultimately there is also at least one indorsee who would typically be

the financial institution servicing the payee's account, or in some

circumstances may be a third party to whom the payee owes or wishes to

give money.

Cheque crossed generally:

Where a cheque bears across its face an addition of the words "and

company" or any abbreviation thereof, between two parallel transverse lines,

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or of two parallel transverse lines, simply, either with or without the words

"not negotiable", that addition shall be deemed a crossing, and the cheque

shall be deemed to be crossed generally

Cheque crossed specially:

Where a cheque bears across its face an addition of the name of a banker,

either with or without the words "not negotiable", that addition shall be

deemed a crossing, and the cheque shall be deemed to be crossed specially,

and to be crossed to that banker.

Crossing after issue:

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.

Where a cheque is crossed generally or specially, the holder may add the

words "not negotiable".

Where a cheque is crossed specially, the banker to whom it is crossed may

again cross it specially to another banker, his agent, for collection.

Payment of cheque crossed generally:

Where a cheque is crossed generally, the banker on whom it is drawn shall

not pay it otherwise than to the banker

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Payment of cheque crossed specially:

Where a cheque is crossed specially, the banker on whom it is drawn shall

not pay it otherwise than to the banker to whom it is crossed or his agent for

collection

Payment of cheque crossed specially more than once:

Where a cheque is crossed specially to more than one banker, except when

crossed to an agent for the purpose of collection, the banker on whom it is

drawn shall refuse payment thereof.

Payment in due course of crossed cheque:

Where the banker on whom a crossed cheque is drawn has paid the same in

due course, the banker paying the cheque, and (in case such cheque has

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come to the hands of the payee) the drawer thereof, shall respectively be

entitled to the same rights, and be placed in the same position in all respects,

as they would respectively be entitled to and placed in if the amount of the

cheque had been paid to and received by the true owner thereof.

Payment of crossed cheque out of due course:

Any banker paying a cheque crossed generally otherwise than to a banker, or

a cheque crossed specially otherwise than to the banker to whom the same is

crossed, or his agent for collection, being a banker, shall be liable to the true

owner of the cheque for any loss he may sustain owing to the cheque having

been so paid.

Cheque bearing "not negotiable":

A person taking a cheque crossed generally or specially, bearing in either

case the words "not negotiable", shall not have, and shall not be capable of

giving, a better title to the cheque than that which the person from whom he

took it had.

Non-liability of banker receiving payment of cheque A banker who has in

good faith and without negligence received payment for a customer of a

cheque crossed generally or specially to himself shall not, in case the title to

the cheque proves defective, incur any liability to the true owner of the

cheque by reason only of having received such payment

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Maturity of an instrument.

The maturity of a promissory note or bill of exchange is the date at which it

falls due.

Days of grace.-Every promissory note or bill of exchange which is not

expressed to be payable on demand, at sight or on presentment is at maturity

on the third day after the day on which it is expressed to be payable.

ILLUSTRATION:-

A bill dated 30th November is made payable three months after date.

It falls due on 3rd March.

A note dated 1st January is payable one month after sight. It falls due

on 4th February.

Calculating maturity of bill or note can be done according to:-

(1) Payable so many months after date or sight.

(2) Payable so many days after date or sight.

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ILLUSTRATION of Maturity of an instrument:-

A bill dated 30th November is made payable three months after date.

It falls due on 3rd March.

A note dated 1st January is payable one month after sight. It falls due

on 4th February.

Classification of negotiable instrument

1. Accommodation bill :

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This type of bill of exchange most commonly used in Australian financial

markets. The accommodation bill grew out of the trade-related bills of

exchange which had been widely used since the last century in financing

world trade. At present, accommodation bills are a means of providing

finance (lending) without necessarily having an underlying trade transaction

(whereas trade bills are based on specific transactions). Accommodation

parties are defined under the Bills of Exchange Act 1909 - 1973 thus:

'Accommodation party to a bill is a person who has signed a bill as drawer,

without receiving value thereof, and for the purpose of lending his name to

some other person.' The idea behind the accommodation bill is to lend the

weight of the stronger party's name (through accepting/drawing/endorsing

the bill) to another party whose name is less marketable.

Illustration:

- A is in need of Rs. 5000, approaches friend B to borrow money.

- B suggests A to draw bill on him which he accepts.

- A gets bill discounted with the banker.

- Meets his requirements.

- On due date, A pays Rs. 5000 to B.

- B would honor the bill.

- Thus B would honor the bill, B has accommodated A.

2. FICTITIOUS BILL:

A bill is fictitious when both the drawer and payee are fictitious persons.

Where the drawer is also the payee of the bill, without any intention that

payment shall be in conformity with the instrument, the instrument is

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fictitious. Also when payee is non-existing, the instrument is fictitious. A

fictitious bill in the hands of a holder in due course becomes a good bill. The

acceptor is liable to a holder in due course, if the holder in due course can

show that the signature of the supposed drawer and that of the first endorser

or payee are under the same hand. The liability of the holder in case of a

fictitious bill is only towards the holder in due course.

3. ESCROW:

A bill delivered conditionally is called an escrow. Where a bill or note is

delivered conditionally, the liability of the party delivering does not

commence till the happening of the event or the fulfillment of the condition.

Such a bill may also be delivered for a special purpose as collateral security.

It is to be noticed that though a conditional delivery is valid, the condition

attaches exclusively to the delivery and this does not affect the rule that the

bill or note must be made conditional.

Illustration of ESCROW:

A makes a note in favour of his servant and hands it to his solicitor telling to

retain the note till his death and then to hand it to the servant if he should

still continue in service. If this condition are complied with and the solicitor

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hands over the instrument to the servant, the servant can claim the amount of

the note from the administrators of his master’s estate.

4. INSTRUMENT PAYABLE ON DEMAND:

A promissory note, a bill of exchange in which no time for payment is

specified and Cheque are payable on demand. Therefore, following are the

instruments payable on the demand:

Bills and promissory notes expressed to be payable ‘on demand’ or

‘at sight’ or ‘on presentment’;

Bills and notes where no time for payment is specified; and

Cheque is always payable on demand.

5. BEARER AND ORDER INSTRUMENTS:

An instrument is a bearer instrument when the amount payable thereon is

payable to the bearer and he as a holder and in lawful possession thereof is

entitled to enforce payment due on it.

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6. AMBIGUOUS INSTRUMENTS:

Where an instrument may be construed either as a Promissory Note or bill of

exchange, the holder may at His election treat it as either and the instrument

shall be then forward treated accordingly.

7. INLAND AND FOREIGN INSTRUMENT:

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. Any such instrument not so drawn, made or

made payable shall be deemed to be a foreign instrument. FOREIGN bills of

exchange must be protested for dishonour when such protest is required by

the law of the place where they are drawn (sec. 104). However, a foreign bill

drawn in India need not be so protested. Protest in case of inland bill is

optional. In case of foreign bills, it is absolutely essential.

8. FORGED INSTRUMENT:

An instrument is a forged when it is drawn, made or alternated in writing to

prejudice another man’s rights. The most common form of forgery is signing

another person’s signature, signing the name of fictitious or none existing

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person. Fraudulently writing the name of an existing person is also forgery.

Forgery is a nullity and, therefore, it passes no title. No holder of forged

instruments acquires any right on the instruments. Even a holder in due

course gets no title if he comes into the possession of a forged instrument. A

person has to pay money on a forged instruments by mistake, can recover it

from the person to whom he has paid it.

Dishonour of a Cheque:

The main object of this piece of legislation is to inculcate faith in the

efficacy of banking operations and credibility in transacting business on

negotiable instruments. Section 138, THE NEGOTIABLE INSTRUMENTS

ACT 1881 is intended to prevent dishonesty on the part of the drawer of

negotiable instrument to draw a cheque without sufficient funds in his

account maintained by him in a bank and induces the payee or holder in due

course to act upon it. The dishonour of cheque is now a criminal offence

punishable by imprisonment up to one year or with fine up to the double the

amount of dishonored cheque or with both.

Advent of cheques in the market have given a new dimension to the

commercial and corporate world, its time when people have preferred to

carry and execute a small piece of paper called Cheque than carrying the

currency worth the value of cheque. Dealings in cheques are vital and

important not only for banking purposes but also for the commerce and

industry and the economy of the country. But pursuant to the rise in dealings

43

with cheques also rises the practice of giving cheques without any intention

of honoring them. Before 1988 there being no effective legal provision to

restrain people from issuing cheques without having sufficient funds in their

account or any stringent provision to punish them in the vent of such cheque

not being honoured by their bankers and returned unpaid. Of course on

dishonour of cheques there is a civil liability accrued. However in reality the

processes to seek civil justice becomes notoriously dilatory and recover by

way of a civil suit takes an inordinately long time. To ensure promptitude

and remedy against defaulters and to ensure credibility of the holders of the

negotiable instrument a criminal remedy of penalty was inserted in

Negotiable Instruments Act, 1881 in form of the Banking, Public Financial

Institutions and Negotiable Instruments Laws (Amendment) Act, 1988,

which were further, modified by the Negotiable Instruments (Amendment

and Miscellaneous Provisions) Act, 2002[3]. This article endeavors to

elucidate the penal provision [4] light of the amendments and the judicial

interpretations.

Scope:

Of the ten sections comprising the chapter of the Act, section 138 creates

statutory offence in the matter of dishonour of cheques on the ground of

insufficiency of funds in the account maintained by a person with the

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banker. Section 138 of the Act can be said to be falling either in the acts

which are not criminal in real sense, but are acts which in public interest are

prohibited under the penalty or those where although the proceeding may be

in criminal form, they are really only a summary mode of enforcing a civil

right. Normally in criminal law existence of guilty intent is an essential

ingredient of a crime.

Circumstances of Dishonour:

The circumstances under which dishonour of cheque takes place or that may

contribute to the situation would be irrelevant and are required to be totally

ignored.

In a Case Study of Rakesh Nemkumar Porwal v. Narayan Dhondu

Joglekar the Bombay High Court held that:

"A clear reading of Section 138 leaves no doubt in our mind that the

circumstances under which such a dishonour takes place are required to be

totally ignored. In such case, the law only takes cognizance of the fact that

the payment has not been forthcoming and it matters little that any of the

manifold reasons may have caused that situation."

Five ingredients of the offence under section 138.

The offence under Sec. 138 of the Act can be completed only with the

concatenation of a number of acts. Following are the acts, which are

components of the said offence;

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1. Drawing of the cheque,

2. Presentation of the cheque to the bank, 

3. Returning the cheque unpaid by the drawee bank, 

4. Giving notice in writing to the drawer of the cheque demanding payment

of the cheque amount. 

5. Failure of the drawer to make payment within 15 days of the receipt of

the notice.

It is not necessary that all the above five acts should have been perpetrated at

the same locality. It is possible that each of those five acts could be done at

five different localities. But concatenation of all the above five is sine qua

non for the completion of the offence under Sec. 138 of the Act.

Drawing of a Cheque:

The drawer in payment of a legal liability to discharge the existing debt

should have drawn cheque. Therefore any cheque given say by way of gift

would not come within the purview of the section. It should be a legally

enforceable debt; therefore time barred debt and money-lending activities

are beyond its scope.

The words any debt or any other liability appearing in section 138 make it

very clear that it is not in respect of any particular debt or liability The

presumption which the Court will have to make in all such cases is that there

was some debt or liability once a cheque is issued. It will be for the accused

to prove the contrary. i.e., there is no debt or any other liability. This of

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course unless the prosecution restricts itself to a particular liability. The

Court shall statutorily make a presumption that the cheques were issued for

the liability indicated by the prosecution unless contrary is to be proved.

Presentation of Cheque:

The presentation of cheque should be within its validity period. Generally a

cheque is valid for six months, but there are cheques whose validity period is

restricted to three months etc. The question arises as to which bank the

cheque should reach within the validity period, is it the payee to his bank

presents that of drawer’s bank or it is enough if the cheque before six

months. The courts are divided on the issue. But common sense demands

that the cheque should reach the drawer bank within the period of validity as

it is that bank that either pays or rejects payment as per the situation existing

on that day.

Returning Of the Cheque Unpaid:

Lot of controversy had arisen on the issue. What reasons are relevant to hold

the drawer of the cheque criminally responsible for bouncing of a cheque?

The case laws on the subject have now made the position clear. It is not what

the bank says in its return memo that is relevant but the actual position as on

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the date when the cheque reaches the drawer bank whether there were

enough funds in the drawer account to honour the cheque.

Notice:

Notice is a very important stage. It is the non-payment of dishonoured

cheque within fifteen days from the receipt of the notice that constitutes an

offence. Issuing of a cheque and its dishonour is not an offence. The offence

is when the drawer receives a notice from the payee and he fails to pay the

dishonoured cheque amount within the grace period of 15 days that

constitute an offence. Any demand made after the dishonour of cheque will

constitute a notice. It is not necessary that the notice should be sent by

Registered Post alone, it could be sent even by fax. It is not necessary that

the notice should be in any particular form or style. What is essential is that

there should be a demand to pay the dishonoured cheque amount.

Amendments of section 138 in 2002:

In section 138 of the principal Act,—

(a) For the words “a term which may be extended to one year”, the words “a

term which may be extended to two years” shall be substituted;

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(b) In the proviso, in clause (b), for the words “within fifteen days”, the

words “within thirty days” shall be substituted.

Limitation:

These being a special legislation certain time limits have been laid down and

they should be strictly followed. Any lapse in adhering to the schedule, shall

take away a cause of action under Sec. 138. The time limits placed cannot be

condoned by the Courts. Therefore the question of making an application for

condonation of delay as in the case of civil does not arise at all under the

said section. What then are the limitations one has to keep in one mind and

follow them strictly to prosecute the drawer of cheque who has failed to pay

the said sum within fifteen days from the receipt of the notice?

• Cheque should be presented to the bank for encashment within its validity

period. 

• Within fifteen days from the receipt of return memo indicating reason of

dishonour, a notice should be sent demanding the amount of dishonoured

cheque. 

• If the drawer does not pay the amount of dishonoured cheque within the

grace period, a complaint thereafter should be filed within one month in the

relevant court of Metropolitan Magistrate/Judicial Magistrate as the case

may be, having jurisdiction.

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Conclusion:

This article does not claim to be all exhaustive one on the subject. But this

should provide a basis and an insight into the main characteristics of the

amendment to the N.I.Act. Making bouncing of cheque a criminal offence. If

this article kindles ones desire to know more, the main purpose can be

considered as fulfilled.

Though insertion of the penal provisions have helped to curtail the issue of

cheque lightheartedly or in a playful manner or with a dishonest intention

and the trading community now feels more secured in receiving the payment

through cheques. However there being no provision for recovery of the

amount covered under the dishonoured cheque, in a case where accused is

convicted under section 138 and the accused has served the sentence but,

unable to deposit amount of fine, the only option left with the complainant is

to file civil suit. The provisions of the Act do not permit any other

alternative method of realization of the amount due to the complainant on

the cheque being dishonored for the reasons of "insufficient fund" in the

drawer’s account.

Case Studies

Q1. What can one do when a cheque is dishonoured for the reason of

insufficient funds? What legal action can he take to get the amount cleared?

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Ans: On the dishonour of a cheque, one can file a suit for recovery of the

cheque amount along with the cost & interest under order XXXVII of Code

of Civil Procedure 1908 ( which is a summary procedure and) can also file

a Criminal Complaint u/s 138 of Negotiable Instrument Act   for punishment

to the signatory of the cheque for haring committed an offence. However,

before filing the said complaint a statutory notice is liable to be given to the

other party.

Q2. Mr. A has got his cheque dishonoured few months back. It was issued

by a Company. What can he do now?

Ans: On the dishonour of cheque   by the company  you can file a suit for

recovery of the amount under Order XXXVII of CPC. As you have stated

that cheques were dishonoured few months back and you have issued no

notice to the company bringing to their knowledge the dishonour of

cheques and the life of the cheque is still valid which is usually six months

from the date of issue. You please present the cheque again and on receipt of

the information about the dishonour of the cheque you immediately issue

notice within 30 days from the receipt of the information of dishonour of

cheque to the company. If the company does not pay the amount within 30

days from the receipt of the notice, you can file complaint under Section 138

of the Negotiable Instrument Act. The said complaint is to be filed within

one month on the expiry of 30 days period of notice.

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Q3. XYZ is the software distribution co. During course of our business we

had supplied software worth Rs.3 lacs. But our client dishonoured the

cheque. We have filed court case on him after that he paid us Rs. 1 lac and

then he has run away. We do not have any idea about his where about. Court

has issued proclaimed offender notice, but we do not now how to trace him.

He has closed his account and bankers are not cooperating with information

like his other address. Please advice?

Ans: Let the proceedings of declaration of proclaimed Offender be

completed. The accused will be declared Proclaimed offender and can be

arrested at any time. At this stage, you can not do anything else. However,

simultaneously you can file Suit for Recovery with the last known address of

the accused.

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