UNIT FOUR
NEGOTIABLE
INSTRUMENTS
NEGOTIABLE
INSTRUMENTS
There
are basically three negotiable instruments
·
Promissory
Note
·
Bill
of Exchange
·
Cheque.
Negotiation
refers to transfer of title (right to receive payment) from one person to
another. The instruments that help the person to achieve this transfer are
called negotiable instruments. This title transfer can be effected based on the
characteristics of respective instruments and the nature of such instruments.
Thus negotiation plays a crucial role.
The
following are the basic aspects of negotiable instruments:
- It is an unconditional instrument in writing, signed by the maker directing a certain person (including himself in the case of a promissory note) to pay a certain sum of the money.
- The money has to be paid to a certain person or as per direction (may be a bearer or an order).
- It has to be dated.
- It is valid only when it is supported by consideration (value received)
Sec 4 of the NI Act 1881 deals with the
promissory note. It is an undertaking in writing, signed by the maker
(promisor) undertaking (promises) to pay to a certain person (promisee) or his
bearer or his order (as the case may be). Accordingly issuing of bearer
promissory note is prohibited as it amounts to currency note.
Section
5 of the NI Act deals with the bill of exchange. A bill of exchange is an
instrument in writing signed by the maker (drawee) to make the payment on the
bill, a certain sum of money to a certain person (payee) or to his bearer or
order. It is an unconditional instrument. Consideration for the transaction is
essential. The Bill has to be dated.
Section
6 of the NI Act deals with cheques. A cheque is a bill of exchange drawn on a
specified banker and payable on demand (Section 72 of the Bill of Exchange Act
1961 – Act 55). All the characteristics of a bill of exchange are applicable to
a cheque. The additional requirement is that it has to be drawn on a particular
bank (specified bank) and is always payable on demand. It is transferred based
on whether it is payable to bearer or order. If payable to bearer then transfer
of title is effected by mere delivery. If it is payable to order, then transfer
is possible by way of endorsement, which is to be followed by delivery.
Crossing (both general as well as special) is applicable only to cheques
(Sec.123 & 124 of NI Act 1881).
FEATURES OF A NEGOTIABLE INSTRUMENT
1. Free Transfer: There is no formality to
be complied with the transfer of a negotiable instrument. It can be very easily
transferred from one person to another, either by mere delivery, or by
endorsement and delivery.
2. Transfer free from defect: It confers an
absolute and good title on the transferee. Even if the transferor has a bad
title to the instrument, he can still pass on a good title to any holder who takes
it in good faith and without negligence and for valuable consideration. Thus it
cuts off prior defects in the instruments.
3. Right to sue: It confers a right on the
holder to sue in his own name, in case of need.
4. No
notice of transfer: The transferor of a negotiable instrument can simply
transfer the document, without serving any notice of transfer to the party who
liable on the instrument to pay.
5. Presumptions regarding negotiable
instrument: It is presumed that the instrument has been obtained for
consideration. Also, there are other presumptions regarding date, time of
acceptance, time of transfer, order of endorsement, stamp, holder to be holder
in due course. (Section 118-119 of the
NI Act).
IMPORTANT
ASPECTS OF NEGOTIABLE INSTRUMENT ACT
Similarities
and differences between a cheque and a bill of exchange
- Both are considered as Negotiable Instruments.
- Both are signed by the maker (drawer) directing the other person (drawee) to make the payment to a certain person or to bearer or the order.
- Both should specify the amount.
- Both should be dated.
- A bill needs to be stamped whereas a cheque need not be stamped.
- A bill may be drawn on any person, whereas a cheque has to be drawn on a specified bank only.
- A bill may be a demand bill or acceptance bill, whereas a cheque should always be a demand instrument.
CHEQUES
A
cheque is a bill of exchange drawn on a specified banker and payable on demand:
An
open (uncrossed) cheque is different from a crossed cheque. In an open cheque,
the intention of the drawer is that his/her bank has to make a cash payment to
the payee. It is also known as payment over the counter. Before making payment
of an uncrossed cheque a drawee banker (paying bank) has to examine certain
aspects such as whether:
- It is a cheque payable to bearer
- It is a cheque payable to order, then the bank may pay only after satisfying about the payee’s identity.
- It is stale cheque (date of the cheque has crossed six months period) / not post dated.
- The words and figures match
- The signature of the drawer / authorized person matches with that of the specimen signature (mandate) lodged with the bank.
- The account has sufficient balance to meet the cheque amount or proper arrangement is made in this regard.
- Any stop payment instrument that has been received is noted or not.
After
satisfying itself with all the above aspects, the paying bank may make the
payment to get necessary protection under the NI Act 1881.
CROSSING
OF CHEQUES.
A
crossed cheque bears two parallel lines on the face of the cheque. Generally,
it is drawn on the left-hand top corner of a cheque. Once a cheque is crossed,
then the paying banker is prevented from making the payment over the counter
(cash payment). A crossed cheque has to be paid through a bank. It should be
routed through a bank account.
TYPES
OF CROSSING
There
are basically two types of crossings: general crossing and special crossing.
GENERAL
CROSSING: The
important requirements of a general crossing are:
- It must have two parallel lines
- In addition, it may contain the words “and company” or “Not negotiable” or any other abbreviations like Account payee only (Sec.75(1) of the Bill of Exchange Act 1961)
i.e.
And Co Not Negotiable A/c Payee
If
the cheque is crossed generally, the same could be collected by any bank who
acts as a collecting banker.
SIGNIFICANCE
OF GENERAL CROSSING
a) The effect of general crossing
is that it gives a direction to the paying banker.
b) The direction is that, the
paying banker should not the cheque at the counter. It should only to a fellow
banker
SPECIAL CROSSING:
The
extension of general crossing leads to special crossing. In addition to the
features of the general crossing, when the name of the bank appears on the face
of the cheque, then the cheque has been crossed specially. Even a mere name of
the bank appearing on the cheque, without crossing also amounts to special
crossing. The addition of the name of a bank is essential for a special
crossing. This will prevent any other bank from acting as a collecting bank. If
a cheque bears a special crossing, then the bank whose name appears has to be
the collecting bank.
Example:
UBA Bank
Account Payee – GCB
In
the above cases, the cheques are to be collected (or routed) through the bank accounts
of respective banks. As compared to a general crossing, the special crossing
gives a better protection.
The
paying bank has to be satisfied that the bank whose name has been mentioned on
the cheque (specially crossed) has collected the cheque. If it overlooks this
and pays, then the same may not be treated as payment in due course.
SIGNIFICANCE
OF SPECIAL CROSSING
a) It is also a direction to the paying
banker. The direction is that the paying banker should pay the cheque only to
the banker whose name appears in the crossing or to his agent.
b) If a cheque specially crossed to a bank
is presented by another bank, not in the capacity of its agent, the paying banker is justified in
returning the cheque.
ACCOUNT PAYEE CROSSING:
The
popular crossing known as “Accounts Payee” crossing is neither defined nor
discussed in any Act. However, in practice, the courts have recognized the
importance of such a type of crossing. Account payee crossing is an indication that
the payment has to go to the payee’s account mentioned. Account payee crossing
serves as a better protection. Both the collecting bank and the paying bank
have their responsibilities with regard to this type of crossing. The
collecting bank has to ensure that it is collecting only for the payee
mentioned. The paying bank has to see that the collecting banker has NOT
collected for any other than the payee mentioned. (House Property Co. of London vs. London Country
and Westminster Bank Ltd 1915)
SIGNIFICANCE
OF A/C PAYEE CROSSING
A/c
payee crossing does not restrict the transferability of cheques. In British
Bank of Middle East vs. Abmal Brothers, the
drawer of a cheque (Abmal Brothers) pleaded, that since the cheque had been
marked a/c payee only, the negotiation on it was null and void, but it was held
that A/c payee crossed cheque can be negotiated. However, if the words “or
order” which appear immediately after the payee’s name are struck through and
if the cheque is crossed A/c payee, that cheque will be considered to be not
transferable.
This
type of crossing gives a further protection to a cheque. This crossing gives a
direction to the collecting banker. The direction is that the collecting banker
should not collect it for any person other than the payee. In other words, the
collecting should ensure that, the cheque is credited only to the account of
the payee. Hence, practically, such cheques cannot be negotiated further.
If
a collecting banker collects such a crossed cheque for any person other than
the payee, it will constitute negligence on the part of the collecting banker
and he will lose protection under the law.
NOT
NEGOTIABLE CROSSING
“Not
Negotiable” crossing serves as a caution to the persons who are dealing with
the cheque. A cheque with a not negotiable crossing can be passed on by the
payee (transferor) to another person (transferee). However, the transferee has
to be careful. Otherwise, he/she would carry the same title the transferor had
at the time of transferring to him or her. If the transferor had a bad title
(i.e. if he were not entitled to receive payment / no title) then the same
would be passed on to the transferee.
SIGNIFICANCE
OF NOT NEGOTIABLE CROSSING
“Not
Negotiable” does not mean not transferable. Not negotiable crossing does not
affect the transferability, but it kills only the negotiability. Negotiability
is something different from transferability. Negotiability is a broader term
which includes transferability. As per law, negotiability means transferability
by mere delivery or endorsement and delivery plus transferability free from
defect. Transferability does not posses the second quality, namely, transfer
free from defect, so one part of negotiability is transferability. In other
words, if a document is a negotiable one, a bonafide transferee who receives it
in good faith and for value paid, can obtain a good title, despite the fact
that the document has prior defect. In case a document is a not negotiable
instrument, the transferee cannot obtain a good title, when there is a prior
bad title.
Hence,
no one can be a holder in due course in the case of a not negotiable
instrument. In Hibernian Bank Ltd. vs. Gysin and Hansan, it was held that the
words “not negotiable” when they appear on a bill must be assigned their
ordinary meaning in law, i.e. the instrument is deprived of one of the most
important characters of negotiable instruments, namely, transferability free
from defects. Thus, a cheque crossed not negotiable can be transferred like any
other cheque, but the transferee cannot obtain a better title than that of the
transferor. “A person taking a cheque crossed generally or specially, in either
case bearing 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 form
whom he took it had.” (Sec. 130 of the Negotiable Instrument Act)
SOME
IMPORTANT ASPECTS OF ENDORSEMENT
a) It has to be in writing.
Generally, it is done on the reverse (back) of the cheque.
b) In case there is sufficient
space for further endorsements, the same can be effected by attaching a piece
of paper to the instrument. This paper which is attached is known as allonge.
In that case, while effecting further endorsements a portion of the same should
appear on the cheque and the other portion on the allonge.
c) For bearer instruments,
transfer of title can be effected by way of mere delivery. Hence, endorsements
do not carry any importance for bearer instruments.
d) For order instruments, the
title can be trandferred only by endorsement and it is only then followed by
delivery. In other words, without proper endorsements, title on an order
instrument cannot be transferred (shifted).
e) Endorsement of a negotiable
instrument, supported by delivery, transfers the right of the property to an
endorsee. He/she has the right to negotiate further.
STOPPED
CHEQUES PROCEDURE
Customers
have the right to stop any cheque they have issued. When stopping a cheque, a
customer must provide his bank with clear and unambiguous details which identifies
the cheque. The “stop” should be in writing and signed by the account holder or
the person mandated to operate the account.
When
a bank returns a stopped cheque, the usual reason to be stated in red on the
cheque is “Payment countermanded by the drawer” or “Orders not to pay”.
Occasionally,
a bank may accept stop instructions from a payee, and when this arises the
reason stated on the cheque for returning it should be “Payment countermanded
at the request of payee – drawer’s confirmation awaited”.
The
bank should be expressly advised of the stop in writing. When notice has been
communicated to the bank and the bank has not actually seen or read it, the
stop is ineffective. When the letter is in the post, the stop is ineffective.
It only becomes effective when the bank opens the letter and becomes aware of
the contents: Curtice vs. London
City and Midland Bank
Ltd. (1908).
In
stopping the payment of any cheque the notification of the correct number is essential. If a customer, when giving his
bank details of a stop provides them with the wrong cheque number, the bank
will not be liable for paying the cheque that the notice was intended to stop.
Westminster Bank Ltd. vs. Hilton (1926). In this case, the bank paid a cheque,
thinking it was a duplicate bearing a later number. The customer advised the
bank for the incorrect number when giving the stop instructions. The House of
Lords held that the bank was absolved from liability, as the one sure means of
identification is the cheque number.
Payment
of Drafts
In the course of the banking
business, bankers issue demand drafts. Demand drafts are order instruments.
While effecting payment of an open draft uncrossed, the banker has to get the
payee’s signature identified (usually from the existing customer) and make the
payment. The protection available for an order cheque under Sec. 85, by virtue
of Sec 85 A is available to the bank for payment of a demand draft.
Material
Alteration
According to Sec. 87 of the NI
Act 1881, “Any material alteration of a negotiable instrument renders the same
void as against anyone who is party thereto at the time of making such
alteration and does not consent thereto, unless it was made in order to carry
out the common intention of the original parties; and any such alteration, if
made by any endorsee, discharges his endorser from liability to him in respect
of consideration thereof”.
The instrument becomes invalid
if it has material alterations. A paying banker will not get protection if he
makes a payment of a cheque which is materially altered. This may be with
regard to the altering of the name of the payee, or the date, or the mismatch
between words and figures or by making the order instruction into bearer. These
alterations may defeat the intention of the drawer, if paid. If the paying
banker makes a payment on a materially altered cheque, then that amounts to
acting with negligence. A materially altered cheque, if paid will not give a
proper discharge. The person making the alteration is responsible for the cheque.
An alteration does not in any way affect the liability of the persons becoming
parties subsequent to the alteration. A holder is not entitled to recover or
get money on the basis of an altered instrument with which he has parted.
QUESTIONS
1. What are the technical points
to look for before passing a cheque for payment?
2. What types of crossing are
usually seen on cheques, and what protection do they give to both the drawer
and the payee?
Reference
Anim-Addo SK- Principles of Banking Laws 3rd
ed (2007), Chartered Institute of Bankers, Accra
Lekshmy & KC Shekhar - Banking Theory and
Practice (19th ed.) 2007) VIKAS Publishing House, New Delhi
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