Negotiable instruments
Chapter 5
Negotiable instrument
• Negotiable instrument
guarantor)
• promissory notes,
• Uses of a bill of exchange
• bills of exchange,
• Acceptance
• banknotes,
• Negotiation of a bill of
exchange
• demand draft and
• Endorsement of a bill of
• cheques.
exchange
• Difference between demand
• Dishonour of a bill of exchange
draft and cheque
• Discharge of a bill of exchange
• Negotiability
• Promissory note
• Parties to a bill of exchange
• Types of bill of exchange
• Accommodation bills (act as a
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Negotiable instrument
• A negotiable instrument is a document guaranteeing the payment
of a specific amount of money, either on demand, or at a set time,
with the payer named on the document. ...
• Examples of negotiable instruments include
•
•
•
•
•
promissory notes,
bills of exchange,
banknotes,
demand draft and
cheques.
• A contract that can be transferred from one person to another.
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Promissory Note
The simplest form of a
credit instrument is the
promissory note.
A promissory note (or pronote for short) is a written
promise from a buyer or a
borrower to pay a certain
sum of money to the
creditor or his order. It is
what we call IOU (I owe
you),
i.e.,
an
acknowledgment of debt
and an obligation to repay.
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Bank Notes
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Demand Draft
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Basis for
Comparison
Cheque
Demand Draft
Meaning
Cheque is a negotiable instrument
which contains an order to the
bank, signed by the drawer, to
pay a certain sum of money to a
specified person.
Demand Draft is a
negotiable instrument
used for the transfer of
money from one place to
another.
Payment
Payable either to order or to
bearer.
Always payable to order
of a certain person.
Issuance
Cheque is issued by an individual.
Demand Draft is issued
by a bank.
Bank Charges
No
Yes
Drawer
Customer of the bank.
Bank itself.
Parties Involved
Three Parties- Drawer, Drawee,
Payee.
Two Parties- Drawer,
Payee.
Dishonour
Yes, due to insufficient balance or
other similar reasons.
No
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Nemo dat rule
("no one gives what he doesn't have”)
• You cannot transfer better title to goods than what you
already have.
• It is a legal rule, sometimes called the nemo dat rule, that
states that the purchase of a possession from someone who
has no ownership right to it also denies the purchaser
any ownership title.
• Exception: Negotiable instruments - can be transferred
from one person to another and that person receives
good title, even if the transferor did not have good title.
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Negotiability
• Assignability (transferability): Capable of being
transferred from one person to another.
• Negotiability: Assignable and allows good title to
pass to the transferee.
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Bill of exchange
• An unconditional order
• In writing
• Addressed by one person (drawer) to another (the drawee)
• Signed by the person giving it (the drawer)
• Pay on demand, or at a fixed or determinable future time
• Involves a certain sum of money
• To the order of a specified person, or to bearer
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Bill of exchange
Advantages
• Proof of debt
• Easily transferred
• Safely transferred
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Parties to a bill of exchange
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Parties to a bill of exchange
1.
2.
3.
4.
5.
6.
Drawer: Person responsible for creating bill (creditor).
Drawee: Person to whom bill addressed (acceptor).
Payee: Person to whom payment is to be made.
Endorser: Person who transfers rights of payment.
Endorsee: Person to whom bill is transferred.
Bearer: Person in possession of bearer bill (a person
who presents a cheque or other order to pay money).
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Parties to a bill of exchange - holders
• Holder: Person in possession (ownership) of a bill “to
bearer”
• Payee or
• Endorsee.
• Holder for value: Person in possession of bill for which
value has been given.
• Holder in due course: Person in possession of bill
• that is complete and regular
• taken in good faith and for value
• no notice of any defect of transferor
• no notice of previous dishonour.
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Types of bill of exchange
• Inland bills
• Foreign bills
• Accommodation bills (acting as a guarantor)
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Specimens of inland bill
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Specimens of Foreign bill
• The definition of a foreign bill of exchange is a payment
drawn up in one country that is payable in another
country.
• An example of a foreign bill of exchange is an agreement
drawn up between two countries for trading purposes.
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Accommodation bills (act as a guarantor)
• Bill of exchange endorsed by a reputable third party (called an
accommodation party or accommodation endorser) acting as a
guarantor, as a favor and without compensation.
• The bill then can be discounted on the financial strength of the
guarantor who remains liable until the bill is paid.
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Uses of a bill of exchange
• Payment of imports
• Payment of exports
• Avoidance of transfers of cash
• Can be discounted
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Liability of partners on a bill of exchange
• Holder has right against
• acceptor
• drawer
• prior endorsers
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Acceptance
•General
•Qualified
• Conditional
• Partial
• Local
• Qualified as to time
• Qualified as to acceptance
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Negotiation of a bill of exchange
When transferred from one person to another:
• Bearer bill - on delivery
• Order bill - endorsement and on delivery
• Payable bill - endorsement by payee and delivery
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Endorsement of a bill of exchange
Elements: - Endorsement written
- Endorser signs
• Blank endorsement: No endorsee named (Payable to
bearer)
• Special endorsement: Endorsee named
• Restrictive endorsement: Cannot be transferred to
anyone else
• Conditional endorsement: Contains a condition
• Sans Recours endorsement:
Endorser not liable if
dishonoured
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Dishonour of a bill of exchange
• On presentation:
• non-acceptance
• non-payment
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Discharge of a bill of exchange
Payment in due (suitable) course (strategy)
• Bill is paid by acceptor
• Acceptor becomes holder
• Bill is cancelled
• Holder waives rights under the bill
• Bill is altered
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Promissory note
• A 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
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Promissory note
Use: Loan Transactions involving two people only
• the maker
• the payee
•Unconditional promise
•By one person to another
•Signed by the maker
•On demand or at a fixed or determinable future
time
•Certain sum of money
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Cheques (Cheque Act 1986 (Cwlth))
• Allows cheques to be drawn on financial institutions
• Contract involving cheques:
Honor customer’s Cheque
Creditor
(Bank)
Debtor
(Customer Cheque holder
charges
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Cheque
• Unconditional order
• Addressed to another person (financial institution)
• Signed by person giving cheque
• Order to pay on demand
• Order to pay a certain sum in money
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Differences between a bill of exchange and a cheque
Basis for Comparison
Cheque
Bill of Exchange
Meaning
A document used to make easy
A written document that shows
payments on demand and can
the indebtedness of the debtor
be transferred through hand
towards the creditor.
delivery is known as cheque.
Defined in
Negotiable Instrument
Negotiable Instrument
Validity Period
3 months
Not Applicable
Payable to bearer on demand
Always
Cannot be made payable on
demand as per RBI Act, 1934
Grace Days
Not Applicable, as it is always
payable at the time of
presentment.
3 days of grace are allowed.
Acceptance
A cheque does not require
acceptance.
Bill of exchange needs to be
accepted.
Stamping
No such requirement.
Must be stamped.
Crossing
Yes
No
Drawee
Bank
Person or Bank
Noting or Protesting
If the cheque is dishonoured it
cannot be noted
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If a bill of exchange is
dishonoured it can be noted or
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protested.
Differences between a bill of exchange and a
cheque
Bill of exchange
Cheque
• Payable on demand, or at a fixed
or determinable future date
• Drawn on anyone
• Payable on demand
• Can’t be crossed
(always negotiable)
• Can be crossed
• Continuing security
• Presented for payment within a
reasonable time
• Drawn on a financial institution
•Obligation from acceptance of bill • Ongoing relationship
•Substantial trading transactions
• Day-to-day transactions
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Similarities
• They are Negotiable Instrument.
• Addressing the drawee to make payment.
• Always in writing.
• Signed by the drawer of the instrument.
• Express order to pay a certain amount.
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Parties involved
• Drawer - Person who writes the cheque.
• Drawee - Bank on which cheque is being drawn.
• Payee - Person to whom cheque is being paid.
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Presentation of cheques
Liability rests with drawer or endorser.
• Drawee institution - Institution upon which the cheque is
drawn.
• Collecting institution - Institution at which the cheque is
presented.
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Types of cheque
Order cheques
• One or more person is specified on the cheque as payee or
endorsee.
• Negotiated by endorsement and delivery.
Bearer cheque (converted to order cheque by deleting “or bearer”)
• No person is specified in the cheque as payee or endorsee, or the
words “to bearer” appear on the cheque.
• Negotiated by delivery.
Crossed cheques
• Specific direction to the drawee financial institution not to pay the
cheque over the counter.
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Crossed cheques
NOT NEGOTIABLE
• To be paid into an account
• Assignable and negotiable if:
• taken in good faith
• for value
• not aware of any defect of title
• good title passes regardless of what title the
giver had
• Assignable
• title the giver had (nemo dat rule applies)- “no
one gives what he doesn't have"
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Crossed cheques
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Payment in due course
•Dishonour of cheque
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Activity
• How does a check become dishonored? List 5
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Dishonour of cheques
1. Revocation by customer of institution’s
authority
2. Insufficient funds in account
3. Stop payment order
4. Account subject to garnishee order
5. Customer’s death
6. Customer’s bankruptcy
7. Material alteration of a cheque
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Revocation of financial institution’s authority to
pay cheques
• Countermand of payments (stop payment order)
• Clear
• Communicated to responsible official
• Given before cheque presented for payment
• Notice of incapacity
• Notice of drawer’s mental capacity
• Notice of drawer’s death
• Unless notice not received from entitled person
within 10 days of drawee bank becoming aware
of drawer’s death.
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Capacity to incur (earn) liability
• Cheque drawn, issued or endorsed by a person
without capacity will not place liability on the
person for the cheque.
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Signature on the cheque
• To be valid, cheque must be signed by drawer,
unless:
• Estoppel (statement of that person)
• Ratification (Approval)
• Agent
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Stale (Out-of-date) cheque
• Date on cheque more than 15 months earlier.
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Endorsement (Authorization) of cheques
1.
2.
3.
4.
Written
Placed on cheque
Signed by endorser (s)
Name misspelt – endorser signs wrong name and right
name
e.g. signature and name of endorsee
5. Endorsements in order of appearance on cheque
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Holder in due course
Has right to:
• Present cheque for payment
• Negotiate it
• Give a valid discharge
• Sue on cheque
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Dishonour
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Holder in due course
In commercial law, a holder in due course is someone who accepts
a negotiable instrument in a value-for-value exchange without
reason to doubt its legitimacy. A holder in due course acquires the
right to make a claim for the instrument's value against its
originator and intermediate holders
Definition:
• Cheque negotiated by holder
• Cheque complete and regular on face of it
• Cheque not stale
• Cheque not crossed “not negotiable”
• Cheque taken in good faith for value
• Cheque without notice of dishonour or defect of transferor’s
title
i.e. holder has legal right to payment
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Discharge of liabilities (legal responsibility)
•Payment in due course
• The payment of a negotiable instrument
to the holder on or after its due date in
good faith by the payer and with no notice
of any defect in title
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Liability of parties to a cheque
• Liability of drawer: For value of cheque at
time of issue
• Liability of endorser: To holder or
subsequent endorsers only
• Liability of “strangers”: A person who
is
willing to “back the cheque” is liable as
an
endorser.
• Liability on dishonour: Sum ordered to
be paid plus amount of interest.
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Duties of drawee
(financial institution) and drawer
Respective parties will not be liable if duties
followed.
• To act in good faith and without negligence
• Collecting institution: to act in good faith and
without negligence.
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Duties of drawee (financial institution) and drawer
Drawee – financial institution
Act in good faith and without
negligence.
If amount fraudulently altered,
pay original amount.
Drawer
Take reasonable care when drawing
cheques to eliminate possibility of
fraudulent alterations.
Take reasonable care to ensure
cheques are not accessible for
forgery.
If crossed cheque, must be paid
into account.
If forged signature, customer’s
account cannot be debited.
If paying on endorsee’s
signature, acting in good faith
and without negligence.
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MCQ for Negotiable Instrument
• ‘Negotiable’ means transferable. In the case of a negotiable
instrument Negotiation can take place from one person to
another:
a)
b)
c)
d)
by mere delivery or by endorsement and delivery.
only by endorsement and delivery.
all negotiable instruments cannot be negotiated
negotiation of a negotiable instrument cannot take place by mere
delivery
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• A promissory note, bill of exchange or cheque is payable to
bearer which is:
a) expressed to be so payable
b) on which the only endorsement is an endorsement in
blank.
c) on which the last endorsement is an endorsement in
blank.
d) expressed to be so payable or on which the only or last
endorsement is an endorsement in blank.
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• Money orders; Postal orders; Fixed Deposit receipts; share
certificates; Letters of Credit are examples of:
a) Negotiable Instruments
b) Non-negotiable instruments
c) some of these are negotiable instruments while others are
not
d) none of given options is correct
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• Bills of lading; dock warrants; railway receipts and
wharfinger certificates are examples of:
a)
b)
c)
d)
negotiable Instruments
non-negotiable instruments
quasi- negotiable instruments
none of the options
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• A Bill of Exchange, not payable on demand, is entitled to
get:
a) 3 days grace period.
b) 7 days of grace period
c) grace period only if the maturity fals due on a bank
holiday
d) none of the options
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• An accommodation bill is not supported by consideration or
a trading transaction. It is drawn with the object of providing
financial help either to drawer or to both drawer and the
drawee. Which of the options is true in case of an
accommodation bill?
a)
An accommodation bill creates no obligation of payment between
the parties to the transaction.
b) The accommodation party is liable on the bill to any subsequent
‘holder for value’.
c) both option A and B are correct
d) none of the given options is correct
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• Which of the options is correct in respect of a negotiable
instrument
bearing
"NOT
NEGOTIABLE"
crossing?
a) mean that the cheque is not transferable
b) It is still transferable, but the transferee cannot get title better than
what transferor had.
c) cheque will be credited only after verification from the
drawer
d) banker is required to keep a separate record of such
instruments
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• In case of dishonor of a negotiable instrument, notice is
required to be given to:
a)
b)
c)
d)
drawer only
all earlier endorsees.
drawer and all earlier endorsees.
all options are correct
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• Where a person receives a negotiable instrument without
consideration, he may be:
a)
b)
c)
d)
called ‘holder in due course’.
a holder
beneficiary
assignee
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• Company is called a legal person or and artificial person, it
implies that:
a) is not a human being.
b) It is created with the sanction of law, and is clothed with certain
rights and obligations
c) company cannot file a suit in a court of law
d) Only options A and B are correct
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• In case of a dishonest and fraudulent use of the facility of
incorporation, the law lifts the corporate veil. What does this
phrase mean?
a) company is not a legal person
b) company will be managed by Board of Directors appointed by the
Government
c) The law will identify the persons who are behind the scene for
perpetration of fraud.
d) none of the options is correct
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• The articles of a company contain:
a) the regulations for management of the company
b) the objects for which the company is proposed to be
incorporated
c) the State in which the registered office of the company is to be
situated;
d) all options are correct
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• Any transaction which is outside the scope of the powers
specified in the objects clause of the Memorandum:
a) requires prior sanction of the central government
b) must be informed to the members in the
report
c) is ultra-vires the company and therefore void
d) requires unanimous consent of the Board of Directors
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• Every person dealing with the company is presumed to have
read The Memorandum and Articles and understood them in
their true perspective. This is known as Doctrine of:
a)
b)
c)
d)
indoor management
Constructive Notice
Ultra vires
Caveat Emptor
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Quiz
1. Define a) Negotiable instrument b) Promissory Note c) Bank Notes
d) Demand Draft e) Bill of exchange
2. Write and explain three advantages of Bill of exchange and parties
involved in it.
3. There are major three types of bill of exchange, list and explain those
three types and list and explain three uses of it
4. Define promissory note
5. Write 5 differences and five similarities of Cheque and bill of
exchange
6. Briefly explain 3 different types of cheque
7. How does a check become dishonored? List 5
8. What are the Liability of parties to a cheque?
9. Explain any duties of a drawer and drawee of a cheque
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