The Negotiable Instruments Act, 1881 - 1 | Law Optional Notes for UPSC PDF Download

Introduction

• This Act aims to define and amend laws concerning promissory notes, bills of exchange, and cheques.
• Applicable to all of India, including Jammu and Kashmir.
• This act came into force on 1st March 1882.

Meaning of Negotiable Instrument

• A negotiable instrument is a transferable piece of paper or document that is written and can be transferred.
• Specifies payment to a specific person or bearer at a specific date.
• Act does not define 'Negotiable instruments', but section 13 mentions promissory note, bills of exchange, and cheques.

Kinds of Negotiable Instruments

• Promissory note - Section 4
• Bills of exchange - Section 5
• Cheque - Section 6

Features of Negotiable Instruments

1. It should be in writing.
2. It should be freely transferable.
3. Creation of Rights and Liabilities: A negotiable instrument should establish the right of a person to receive money and the corresponding obligation of another person to pay money.

• Holder's Title Free from Defects:
  • A holder in due course obtains a valid title regardless of any flaws in a previous holder's title.
  • A holder in due course is someone who acquires the instrument:
    • For value;
    • Without being aware of any defects in the transferor's title, meaning in good faith and before maturity.

4. Transferability: A negotiable instrument can be transferred indefinitely, allowing for multiple transfers until it is settled.

Presumptions - Section 118

• Consideration: It is assumed that every negotiable instrument was created for consideration and that each instance of acceptance, endorsement, negotiation, or transfer was done for consideration.
• Date: It is presumed that a negotiable instrument marked with a date was indeed created on that date.
• Time of Acceptance: Every accepted bill of exchange is thought to have been accepted within a reasonable period after its date and before its maturity.
• Transfer: It is presumed that every transfer of a negotiable instrument occurred before its maturity.
• Order of Indorsement: The order of endorsements is assumed to follow the sequence in which they appear.
• Stamp: It is presumed that an instrument is validly signed and stamped.

Promissory Note - Section 4

Additional details about promissory notes as defined in Section 4.

• Meaning A Promissory Note is a legally binding financial document issued by one party, committing to repay a debt owed to another party.
• Definition "A Promissory note is a written document that includes an unequivocal promise, signed by the maker, to pay a specific sum of money to a designated person, their order, or the bearer of the instrument."
• Note: Bank notes or currency notes are not considered promissory notes.

Parties Involved in a Promissory Note

• Maker: The individual creating the promissory note and committing to make the payment is known as the maker.
• Payee: The recipient of the payment specified in the promissory note is referred to as the payee.

Essentials of a Promissory Note

• The promissory note must be in written form.
• It should include an explicit promise to make a payment.
• The promise to pay must be absolute and without conditions.
• The maker of the note must sign it.
• The amount payable must be clearly defined.
• The document must contain a commitment to pay money and money alone.

Additional Points to Note

• The identities of the maker and payee must be clearly stated.
• Stamping a Promissory Note is mandatory under The Indian Stamp Act, 1899.
• An unstamped promissory note is not admissible as evidence, and legal action cannot be initiated based on it.
• The promissory note should include a date.
• The statute of limitations for filing a lawsuit related to a promissory note is three years from the date of execution or acknowledgment.

Bills of Exchange

• A Bill of Exchange is a written negotiable instrument that contains an unconditional order to pay a specified sum of money to a person or the holder of the instrument, as directed by the maker. It can be payable either on demand or after a specified term.

Definition

• "A bill of exchange is a written instrument that includes an unconditional order, signed by the maker, directing a specific person to pay a certain sum of money to a particular person or to the bearer of the instrument."

Parties to Bills of Exchange

• The Drawer: The individual who gives the order to pay or creates the bill is known as the drawer.
• The Drawee: The person who is directed to make the payment is called the drawee. Upon acceptance of the bill, the drawee becomes the acceptor.
• The Payee: The recipient of the payment specified in the bill is referred to as the payee.

Requisites of a Bill of Exchange

• Every party involved must be clearly identified.
• Each Bill of Exchange must be stamped in accordance with The Indian Stamp Act, 1899.
• The bill should explicitly state the date and place of payment or where it is drawn.
• It must contain an order to pay, which signifies a request or direction, not a command.
• The time and amount of payment must be clearly specified.
• The consideration for a bill of exchange should be in the form of money only.

Other Important Points

• A bill of exchange must be drawn unconditionally, even though subsequent parties may impose conditions.
• The identity of the parties involved in the contract must be clearly indicated.
• The drawee who is called upon to accept or pay the bill must be named or reasonably indicated.

Types of Bills

Inland Bills

Two essential conditions to make an inland instrument are:

• The instrument must have been drawn or made in India.
• The instrument must be payable in India or the drawee must be in India.

Foreign Bills

• All bills which are not inland are deemed to be foreign bills. Normally foreign bills are drawn in sets of three copies.

Trade Bills

• A bill drawn and accepted for a genuine trade transaction is termed as a trade bill. When a trader sells goods on credit, he may make use of a bill of exchange.

Accommodation Bill

• An accommodation bill is a bill in which a person lends or gives his name to oblige a friend or some person whom he knows.
• In other words, a bill which is drawn, accepted or endorsed without consideration is called an accommodation bill.
• The party lending his name to oblige the other party is known as the accommodating or accommodation party, and the party so obliged is called the party accommodated.
• An accommodation party is not liable on the instrument to the party accommodated because as between them there was no consideration and the instrument was only for help.
• But the accommodation party is liable to a holder for value, who takes the accommodation bill for value, though such holder may not be a holder in due course.

Bills in Sets

• Foreign bills are usually drawn in sets to avoid the danger of loss.
• They are drawn in sets of three, each of which is called "Via" and as soon as any one of them is paid, the others become inoperative.

Comparison between Trade Bills and Accommodation Bills

Trade Bill

• Trade bills are drawn and accepted for the same consideration.
• These bills are legally enforceable.
• Trade bills are the acknowledgment of the debt.
• The drawer can sue if the bill is dishonored.
• Loss by way of discounting the bill is borne by the drawer only.

Accommodation Bill

• These bills are drawn and accepted without any consideration.
• These bills are not legally enforceable.
• Accommodation bills are not the acknowledgment of debt.
• Drawer cannot sue if the bill is dishonored.
• Loss by way of discounting the bill is shared by the drawer and drawee in the ratio of their sharing in the proceeds of the bill.
• All the components together constitute a single bill, and the drawer must sign and hand over all sections to the payee.
• The stamp is only affixed to one part, and one part necessitates acceptance.
• If the drawer mistakenly accepts all parts of the same bill, they become liable for each part as if it were an individual bill.

Bank Draft

• It is a bill of exchange drawn by one bank on another bank, or by a bank on its own branch, and if it is negotiable, it is termed as a bank draft.
• A bank draft can only be drawn by a bank on another bank.
• It cannot be easily revoked or canceled.
• It cannot be made payable to bearer.

Cheque - Section 6

Meaning

• Any individual can draw a cheque.
• A cheque can be revoked or canceled.
• A cheque can be made payable to bearer.
• A cheque is an unconditional order to the bank to pay a specified sum to the payee or bearer.

Definition

• A cheque is a type of bill of exchange drawn on a specific banker and payable on demand. It encompasses electronic forms of cheques.

Requisites (Essentials) of a Cheque

• A cheque must be a written order.
• It must contain an unconditional order.
• The maker must sign the cheque.
• The amount must be clearly stated in both figures and words.
• A cheque can be payable to the order or bearer.
• There are two prevalent types of cheques: bearer or order cheques, and self-cheques.
• The cheque should include the date.
• The payee must be clearly specified.

Acceptance - Section 7

Meaning

• The acceptance of a bill signifies the drawee's agreement to the drawer's order.
• Acceptance involves the drawee signing their assent on the bill and delivering it to the holder.

Essentials of Valid Acceptance

• Must be in writing.
• Should be signed by the drawee or their agent.
• On a bill of exchange.
• Completed by delivery to the holder.
• The word 'Accepted' written is not necessary for validity.
• Oral acceptance or writing 'Accepted' without the drawee's signature is not valid.

Acceptor for Honor

• Meaning: It refers to a third party agreeing to accept and pay a dishonored bill of exchange, either partially or fully, on behalf of the drawer or an endorser.
• How acceptance for honor should be made: A person accepting for honor must declare in writing that they accept under protest the protested bill for the honor of the drawer or a specific endorser.
• Rights and liabilities of acceptor for honor:
  • Commits to pay the bill amount if the drawee defaults.
  • Liability is conditional and arises only upon drawee's failure to pay.
  • Entitled to recover losses and damages from the drawee.

Holder - Section 8

Definition of "Holder": Refers to any individual entitled in their own name to possess and receive the amount due on a promissory note, bill of exchange, or cheque from the involved parties.

Key Points

• Rights and title of the holder depend on the transferor.
• Has the right to demand and receive the amount but lacks the right to sue.

Note:

• Not every individual possessing the instrument is termed a holder.
• To qualify as a holder, the person must be either named in the instrument as the payee or endorsee, or be the bearer of it.
• Someone who acquires an instrument through theft or a forged endorsement is not a holder and cannot claim the instrument.
• An agent holding an instrument for the principal is not considered a holder, even if they receive payment on behalf of the principal.
• The term "holder" signifies a de jure (holder in law) and not a de facto (holder in fact) holder.

Holder in Due Course - Section 9

A holder in due course is an individual who:

• Receives the instrument for consideration.
• Accepts the instrument in good faith without knowing about any defects in the transferor's title.
• Receives the instrument before its maturity.

Note:

• His rights and title are independent of the transferor.
• He has the right to demand, receive, and sue.

Payment in Due Course - Section 10

Payment in due course entails:

• Adhering to the evident terms of the instrument while making the payment in good faith and without negligence to the rightful holder.

A payment is considered in due course if:

• It aligns with the apparent terms of the instrument.
• It is made in good faith and without negligence.
• It is directed to the rightful holder entitled to receive the payment.
• The payment is made in legal tender only.

Classification of Negotiable Instruments

• For negotiable instruments to be payable to bearers:
  • The parties involved must expressly state it to be payable to bearers or endorse it in blank.
  • A bearer instrument holder can claim payment.

Order Instruments

• These instruments are payable as expressly stated and may be directed to a specific person.
• They should not have any restrictions on their transfer.

Inland Instruments 

• An inland instrument is either drawn and payable in India or drawn in India on residents of India, even if payable in a foreign country.

Foreign Instruments 

• Any instrument originating outside India is considered a foreign instrument.
• These instruments can be drawn in a foreign country but may be payable within or outside India.
• An instrument must be drawn in India, made payable outside India, and drawn on a person residing outside India to qualify as a foreign instrument.

Demand Instruments

• These are negotiable instruments with no specified time for payment, known as demand instruments.

Time Instruments

• Time instruments have a fixed future payment date.
• They are payable at a specific date in the future.

Ambiguous Instruments

• An ambiguous instrument is one that can be interpreted as either a bill or a note by the holder.
• The holder can choose to treat such instruments as bills of exchange or promissory notes.
• For instance, if the drawee is fictional or legally incompetent, the instrument may be ambiguous.

Incomplete Instruments

• Incomplete instruments lack essential features of typical negotiable instruments.
• The holder has the authority to complete incomplete instruments up to the mentioned amount.
• Upon completion, a legally binding negotiable instrument is created, enforceable by law.

Amount Discrepancy - Section 18

• If the figures and words on an instrument display different amounts, the amount in words takes precedence for payment.

Maturity - Sections 22, 23, and 24

Definition of Maturity

• Maturity of a promissory note or bill of exchange signifies its due date.

Days of Grace

• Instruments not payable on demand, at sight, or on presentment mature three days after the specified date.
• All instruments, except those payable on demand, allow a 3-day grace period.

Calculation of Maturity

• For negotiable instruments with a specified payment date, they become due on that date plus a 3-day grace period.

Grace Periods in Negotiable Instruments

When a negotiable instrument is payable after a specified number of days from the date, sight, or a certain event, it becomes due on:

• The date of drawing the negotiable instrument, with an additional 3 days of grace.
• The date of presenting the negotiable instrument for sight, with an additional 3 days of grace.
• The date when the specified event occurs, with an additional 3 days of grace.

Payment after Months

When a negotiable instrument is payable after a specified number of months from the date, sight, or a certain event, it becomes due on:

• The corresponding day of the relevant month when the instrument is drawn, with 3 days of grace.
• The corresponding day of the relevant month when the instrument is presented for sight, with 3 days of grace.
• The corresponding day of the relevant month when the event happens, with 3 days of grace.

Examples:

• A negotiable instrument dated 31st January, 2020, payable one month after the date matures on 3rd March, 2020.
• A negotiable instrument dated 30th August, 2020, payable three months after the date matures on 3rd December, 2020.

Considerations

• If the last day of grace falls on a public holiday, the instrument is due on the preceding business day.
• If the maturity date coincides with an emergency or unforeseen holiday, the maturity date shifts to the following business day.

Negotiation of Negotiable Instruments

• Meaning of Negotiation: Transfer of an instrument to another person to confer holder status constitutes negotiation.
• Modes of Negotiation:
  • In the case of Promissory Notes (PN), Bills of Exchange (BOE), and bearer cheques, negotiation occurs through delivery.
  • In the case of PN, BOE, and cheques payable to order, negotiation involves endorsement followed by delivery.
• Negotiation Back: The process of re-transferring the instrument to the original holder.

Instrument Negotiation Scenarios

• When an endorser negotiates an instrument and becomes its holder again, it is negotiated back to that endorser, absolving intermediary endorsees of liability.
• Example: Raju endorses a bill to Shyam, who further endorses it to Babu Bhai, and then to Anuradha, who endorses it back to Raju. Raju, as a holder in due course, can recover from Shyam, Babu Bhai, or Anuradha, but cannot sue them due to being relegated to the original position.

Endorser Liability Exclusion

• If an endorser excludes liability and later becomes the holder, all intermediate endorsers are liable to him.
• Illustration: Raju endorses 'sans recourse' to Shyam, with subsequent endorsements to Babu Bhai, Anuradha, and finally back to Raju. In this case, Raju retains his rights and can claim against Shyam, Babu Bhai, and Anuradha.

Delivery under Section 46

• The completion of a promissory note, bill of exchange, or cheque occurs through delivery, which can be actual or constructive.

Endorsement

Meaning of Endorsement

• Endorsement involves signing at the back of an instrument for negotiation purposes.
• It is the act of signing a cheque to transfer it to someone else.
• If there's no space on the instrument, endorsement can be done on a separate slip attached to it.

Definition of Endorsement

• When the maker or holder signs a negotiable instrument for negotiation, they are considered the endorser.

Kinds of Endorsement

• Endorsement in Blank / General: An endorsement is blank when the endorser only signs the instrument without specifying a payee.
• Endorsement in Full / Special: An endorsement is special if the endorser, along with a signature, mentions the payee's name for payment.
• Endorsement refers to the direction added by an endorser to the specified person, known as the endorsee, in an instrument. The endorsee then becomes the payee and is entitled to pursue legal action for the money owed on the instrument.
• Partial Endorsement: Partial endorsement occurs when an instrument transfers only a portion of the amount specified, rather than the full amount. Such endorsements are considered invalid under Section 56 of the law.
• Conditional Endorsement: An endorsement is deemed conditional or qualified when it imposes limits or exceptions on the endorser's liability. The endorser can restrict liability in various ways, such as through sans recourse endorsement or by linking liability to a specific event.
• Restrictive Endorsement: Restrictive endorsement aims to alter the fundamental characteristics of a Negotiable Instrument and limit its further negotiability. By restricting subsequent transfers, this type of endorsement prevents unauthorized individuals from obtaining payment through fraud or forgery, thus safeguarding the drawer's funds.
• Endorsement Sans Recourse: The term "Sans Recourse" means without recourse or reference. When a negotiable instrument is transferred sans recourse, the endorser disclaims liability and exempts themselves from responsibility to subsequent endorsees. This form of qualified endorsement, which is common, essentially hinders negotiation as the endorser indicates a lack of liability.

Who May Negotiate Instrument - Section 51

• Section 51 specifies that any sole maker, drawer, payee, or endorsee, as well as joint makers, drawers, payees, or endorsees of a negotiable instrument, have the authority to endorse and negotiate the instrument.

Instrument Obtained by Unlawful Means or Unlawful Consideration - Section 58

• Section 58 addresses situations where a negotiable instrument is lost or acquired through illegal methods, fraud, or for an unlawful consideration. In such cases, specific legal provisions apply to safeguard the rights of the parties involved.
• In the context of negotiable instruments, a possessor or endorsee who claims rights through a person who found or obtained the instrument is only entitled to receive the amount due from the maker, acceptor, or holder if they are a holder in due course or someone through whom they claim was a holder in due course.

Liabilities of Parties

Liability of a Minor

• A minor, due to being legally incompetent to contract, cannot be held liable by becoming a party to a negotiable instrument. Regardless of the role (drawer, maker, acceptor, endorser), a minor is not personally liable on the instrument. 
• Section 26 explicitly states that a minor binds all parties except themselves.

Liability of an Agent

• Every individual capable of entering into a legal contract has the authority to create, draw, accept, endorse, deliver, and negotiate negotiable instruments either personally or through a duly authorized agent.
• A general authority to conduct business and settle debts does not grant an agent the power to endorse bills of exchange in a manner that binds their principal.
• An agent cannot avoid personal liability unless they explicitly indicate that they are signing as an agent and do not intend to assume personal liability.

Liability of Legal Representative

• The legal representative of a deceased individual who signs their name on an instrument is personally liable for the full amount, but they can limit their liability to the extent of assets received as a legal representative.

Liability of Drawer

• Typically, the liability of the drawer of a bill or check is secondary and contingent.
• In contrast, the liability of the acceptor, maker of the bill, and drawee of the check is primary and absolute.
• The drawer's liability is conditional, only arising upon dishonor by the drawee or acceptor.
• Upon dishonor and notification to the drawer, they are obligated to compensate the holder, regardless of the account status between themselves and the drawee or acceptor.

Liability of Drawee Bank of Cheque

• Wrongful dishonor of a customer's check by the bank results in exemplary damages against the bank, with the amount of damages inversely related to the dishonored check's amount.

Liability of Drawee of Bill of Exchange / Maker of Promissory Note

• The maker of a promissory note is obligated to pay the amount at maturity.
• The drawee's liability emerges upon acceptance of the bills, which is primary and absolute.
• The drawee is liable for the principal amount, interest, and any noting/protesting charges.

Liability of Maker, Drawer, and Acceptor as Principals

• The maker of a promissory note is liable as the principal debtor.
• In a bill of exchange, the acceptor acts as a principal debtor, and the drawer acts as a surety. The drawer is liable to pay only if the acceptor defaults.

Effect of Forged Indorsement on Acceptor's Liability

• A bill may be accepted before or after endorsement by the payee.
• An acceptor of a bill of exchange already endorsed is not relieved from liability by reason that such endorsement is forged.

Liability of Acceptor of a Bill Drawn in a Fictitious Name

• The acceptor is not relieved from liability by proving that the drawer is fictitious.

Liability on an Instrument Made, Drawn, etc. Without Consideration

• An instrument made, drawn, accepted, endorsed, or transferred without consideration creates no obligation of payment between the parties to the instrument.