The Law Relating to Negotiable Instruments

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Introduction

As commerce and trade developed, people moved beyond exclusive reliance on barter to the use of money and then to the use of substitutes for money. The term negotiable instrument encompasses such substitutes in common use today as checks, promissory notes, and certificates of deposit.

History discloses that every civilization that engaged to an appreciable extent in commerce used some form of negotiable instrument. Probably the oldest negotiable instrument used in the carrying on of trade is the promissory note. Archaeologists found a promissory note made payable to bearer that dated from about 2100 BC. The merchants of Europe used negotiable instrument, which under the law merchant was negotiable in the 13th and 14th centuries. Negotiable instrument does not appear to have been used in England until about 1600 AD.

This paper tries to outline and discuss the body of law that governs negotiable instrument. Of particular interest are those kinds of negotiable instrument having the attribute of negotiability—that is, they generally can be transferred from party to party and accepted as a substitute for money. This paper also discusses about dishonor of a negotiable instrument, Hundis and in the later part, the legal relationship between bankers and customers.

Chapter: 1

Negotiable Instruments

The law relating to "negotiable instruments" is contained in the Negotiable Instruments Act, 1881, as amended up-to-date. The Act extends to the whole of India. It deals with three kinds of negotiable instruments, i.e., Promissory Notes, Bills of Exchange and Checks, these being in most common use. The provisions of the Act also apply to 'Hundis' (an instrument in oriental language), unless there is a local usage to the contrary. Other documents like Treasury Bills, dividend warrants, share warrants, bearer debentures, Port Trust or Improvement Trust Debentures, Railway bonds payable to bearer, etc., are also recognized as negotiable instruments either by mercantile custom or under other enactments like the Companies Act, 1956, and therefore, Negotiable Instruments Act is applicable to them.

Definition

The word negotiable means 'transferable by delivery,' and the word instrument means 'a written document by which a right is created in favor of some person.' Thus, the term "negotiable instrument" literally means 'a written document transferable by delivery.'

According to Section 13 of the Negotiable Instruments Act, "a negotiable instrument means a promissory note, bill of exchange or check payable either to order or to bearer." "A negotiable instrument may be made payable to two or more payees jointly, or it may be made payable in the alternative to one of two, or one or some of several payees" [Section 13(2)].

The Act, thus, mentions three kinds of negotiable instruments, namely notes, bills and checks and declares that to be negotiable they must be made payable in any of the following forms:

  1. Payable to order: A note, bill or check is payable to order which is expressed to be 'payable to a particular person of his order.' But it should not contain any words prohibiting transfer, e.g., 'Pay to A only' or 'Pay to A and none else' is not treated as `payable to order' and therefore such a document shall not be treated as negotiable instrument because its negotiability has been restricted. It may be noted that documents containing express words prohibiting negotiability remain valid as a document (i.e., as an agreement) but they are not negotiable instruments as they cannot be negotiated further. There is, however, an exception in favor of a check. A check crossed "Account Payee only" can still be negotiated further, of course, the banker is to take extra care like a bloodhound in that case.

  1. Payable to bearer: `Payable to bearer' means 'payable to any person whosoever bears it.' A note, bill or check is payable to bearer which is expressed to be so payable or on which the only or last endorsement is an endorsement in blank. Thus, a note, bill or check in the form "Pay to A or bearer," or "Pay A, B or bearer," or "Pay bearer" is payable to bearer. In addition, where an instrument is originally 'payable to order,' it may become ‘payable to bearer’ if endorsed in blank by the payee.

Section 31 of the Reserve Bank of India Act:

It is important to note that the above definition is subject to the provisions of Section 31 of the Reserve Bank of India Act, 1934, which as amended by the Amendment Act of 1946, provides as under:

1. No person in India other than the Reserve Bank or the Central Government can make or issue a promissory note 'payable to bearer.'

2. No person in India other than the Reserve Bank or the Central Government can draw or accept a bill of exchange 'payable to bearer on demand.'

3. A check 'payable to bearer on demand' can be drawn on a person's account with a banker.

The effect of the above provisions is that-

(i) A promissory note cannot be originally made 'payable to bearer,' no matter whether it is payable on demand or after a certain time. It must be made 'payable to order' initially. However, on being endorsed in blank it can become 'payable to bearer' or `payable to bearer on demand' subsequently and it shall be valid in that case.

(ii) A bill of exchange may be originally made 'payable to bearer' but it must be payable otherwise than on demand (say, payable three months after date) in that case. If it is 'payable on demand' then it must be made (payable to order.' However, on being endorsed in blank subsequently, it can become 'payable to bearer on demand.'

(iii) A check drawn on a bank can be originally made 'payable to bearer on demand' and it shall be valid. In fact checks are always payable on demand.

More comprehensive definition:

The definition given in Section 13 of the Negotiable Instruments Act does not set out the essential characteristics of a negotiable instrument. Possibly the most expressive and all-encompassing definition of negotiable instrument had been suggested by Thomas, which is as follows:

"A negotiable instrument is one which is, by a legally recognized custom of trade or by law, transferable by delivery or by endorsement and delivery in such circumstances that (a) the holder of it for the time being may sue on it in his own name and (b) the property in it passes, free from equities, to a bona fide transferee for value, notwithstanding any defect in the title of the transferor."

Chapter: 2

Dishonor of A Negotiable Instrument

Mode of Dishonor

A negotiable may be dishonored either by non-acceptance or by non-payment. Only bills of exchange can be dishonored by non-acceptance, since only bills of exchange require acceptance. Promissory notes, bills of exchange and checks can be dishonored by non-payment.  

Dishonor by non-acceptance

1. “When after due presentation, the bill is not accepted by drawee.” When there are several drawees (who are not partners), refusal by any one of the drawees will amount to dishonor.

2. When presentment for acceptance is excused and the bill remains unaccepted.

3. When tile drawee is incompetent to contract.

4. When the drawee is a fictitious person or after reasonable search cannot be found.

5. Where the acceptance is a qualified one or where one or some of several drawees not being partners make default in acceptance, on being duly required to accept. In this case, the holder may at his own risk treat die bill as accepted.

6. Drawee in case of need: Where a drawee in case of need is named in a bill, or in any endorsement thereon, the bill is not dishonored until it has been dishonored by such drawee. [Sec. 115]

Dishonor by non-payment

A promissory note, a bill of exchange or check is said to be dishonored by non-payment when the maker of the note, acceptor of the bill or drawee of the check makes default in payment upon being duly required to pay the same (Sec. 92). In addition, a negotiable instrument is dishonored by non-payment when presentment for payment is excused and the instrument when overdue remains unpaid (Sec. 76).

A drawee in case of need must accept, or pay a bill when presentment is made. A bill will be dishonored if the drawee in case of need also refuses to accept or pay after acceptance.

Effect of Dishonor

When a negotiable instrument is dishonored, the holder

  1. Becomes entitled to file a suit for the recovery of the amount due from the parties liable to pay.
  2. He must, subject to certain explanation, give notice of dishonor to parties against whom he intends to proceed.
  3. He may also have the instrument noted and protested before a notary public.  

Notice of Dishonor

When a negotiable instrument is dishonored either by non-acceptance or by non-payment the holder or some party liable thereon must give notice of dishonor to all other parties whom he seeks to make liable (Sec. 93). Each party receiving notice of dishonor must, in order to render any prior party liable to himself, give notice of dishonor to such party within a reasonable time after he has received it (Sec. 95). Notice of dishonor is so necessary that an omission to give notice discharges all parties other than the maker or acceptor. These parties are discharged not only on the bill or note but also in respect of the original consideration.

By and to whom notice should be given (Sections 93, 95-97):

Notice of dishonor must be given by the holder, or by a person liable on the instrument. When the holder has given notice of dishonor to any party liable on the bill, and that party has in turn given due notice of dishonor to all prior parties, the holder may in a suit against the drawer take advantage of notice given by that party and treat it as a notice by himself. The agent of any of the above parties may give notice. But a notice by a stranger is a mere nullity for a valid notice can be given only by a parson who is liable on the instrument at the time of the notice or by his agent.

Notice of dishonor to the acceptor of a bill or to the maker of a note or the drawee of a check is not necessary as they are the principal debtors and primarily liable on the instrument, and they must pay on the due date at the proper place. It is they who dishonor the instrument by non-acceptance or non-payment, and to give them notice is to tell them something which they already know. Notice of dishonor must be given to all parties other than the maker or acceptor or drawee whom the holder wants to be made liable. Notice may also be given to the duly authorized agent of the party.

Where the drawee or endorser is dead, the notice may be given to the legal representative of the deceased. Likewise, the notice may be given to die Official Receiver or Assignee where the party has been declared all insolvent. In case of two or more joint drawers or endorsers, notice to one of them will bind all.

Mode in which notice may be given (Section 94):

  1. Notice may be oral or in writing, but it must be an actual, formal notification. A letter merely demanding payment is not sufficient. It may be given in person, or through a messenger, or by post. Notice by post is more expedient, for if die letter is properly addressed and miscarries or is delayed in transit; the sender is not responsible once he has posted it into the post box.

  1. Notice must be given within a reasonable time of dishonor. As to what is a reasonable time will depend upon the nature of the instrument and the usage of trade in regard to similar instruments (Sec. 105).

  1. Where the holder of the instrument and the party to whom notice is given carry on business or live in different places, the notice of dishonor must be posted by the next post if there be one on the day, or on the next day of dishonor. Where the said parties carry on business or live in- die same place, it is sufficient if the notice is dispatched so that it reaches its destination on the day next after the day of dishonor (Sec. 106).

  1. Any party receiving notice of dishonor, who seeks to enforce right against a prior party, transmits the notice within a reasonable time if he transmits it within the same time after it, receipt as he would have had to give notice if he had been the holder (Sec. 107). Thus, each party is entitled to a clear day for giving notice and one clear day is to be allowed for each step in the communication between parties who are liable on the instrument. But a holder or endorser, who wants to give notice to all parties, cannot claim as many days as there are endorsers. He must give notice to all whom he wants to hold liable within the time in which he is to give notice to his immediate endorser.

Consequence of not sending notice of Dishonor:

Any person to whom notice of dishonor is not sent is discharged from his obligations under the instrument. He is not liable to pay and no suit can be filed against him.

Notice of Dishonor Unnecessary:

We have seen above that in a suit against the drawer or endorser on a dishonored instrument notice of dishonor is a material part of the cause of action. However, Sec. 98 enumerates cases in which notice of dishonor can be dispensed with.

No notice of dishonor is necessary-

  1. When it is dispensed with or waived by the party entitled thereto, e.g., where an endorser writes on the instrument such words as "notice of dishonor waived" or where the drawer of the bill informs the holder that the bill will be dishonored on presentment, or where he tells the holder before maturity that he has no fixed residence, and that he will call in a few days to see if the bill has been paid by the acceptor.

  1. When the drawer has countermanded payment. This is so because he has made it impossible for the holder to obtain payment. [Sec. 98 (b)]

  1. When the party charged could not suffer damage for want of notice, e.g., if at the time when the instrument is drawn there were no funds belonging to the drawer in the hands of the drawee, the drawer suffers no damage, and is not entitled to notice of dishonor. But the burden of proving that the drawer could not suffer damage for want of notice is on the person seeking to excuse himself. [Sec. 98 (c)]

  1. When the party entitled to notice cannot after due search be found. [Sec. 98 (d)]

  1. Where the omission to give notice is caused by unavoidable circumstances, e.g., death or dangerous illness of the holder or his agent, or any other accident.

  1. When the acceptor is also a drawer, e.g., where a firm draws on its branch, or a partner on the partnership. No notice is necessary where the acceptor is one of the drawers.

  1. Where the promissory note is not negotiable. Such a note cannot be endorsed; and if it is endorsed, the endorsee cannot have any claim against the maker or endorser. Therefore, no one is prejudiced for want of notice. [Sec. 98 (f)]

  1. Where the party entitled to notice promises to pay unconditionally the amount due under an instrument after dishonor and with full knowledge of facts. [Sec. 98 (g)]

Notary Public

The notary public is an officer appointed by the Government to exercise the functions of a Notary Public as laid down in the Negotiable Instruments Act. (Noting, Protest etc.).

The term “Notary Public”, includes the notary public of a foreign country also. Gujrat Singh v. Jaswant Singh. 

Noting

Where a note or bill is dishonored, the holder is entitled, after giving due notice of dishonor, to sue the drawer and the endorsers. Sec. 99 provides a convenient method of authenticating the fact of the dishonor by means of "Noting." Where a note or bill is dishonored, the holder may, if he so desires cause such dishonor to be noted by a notary public on the instrument, or on a paper attached thereto or partly on each. The "Noting" or minute must be recorded by the notary within a reasonable time after dishonor and must contain the fact of dishonor, the date of dishonor, the reason, if any, assigned for such dishonor, or, if the instrument has not been expressly dishonored, the reason why the holder treats  it as dishonored and the notary's charges.

Noting is not compulsory in the case of an inland bill or note, but foreign bills must be protested, if so required by the law of the place where drawn.

Advantages of Noting:

Noting is a convenient method of regarding the fact of dishonor. If a suit is subsequently filed in the instrument, the notary public may give evidence about presentment and dishonor. A bill of exchange may be accepted for dishonor and paid for honor after it is noted.

Protest

The protest is the formal notary certificate attesting the dishonor of the bill, and based upon the noting which has been effected on the dishonor of the bill. After the noting has been made within the specified or reasonable time, the formal protest may be drawn up by the notary at his leisure; and when the protest is drawn up it relates back to the date of noting. [Sec. 100]

Protest for better security:

Where the acceptor of a bill has become insolvent, or has suspended payment, or his credit has been publicly impeached, before the maturity of the bill, the holder may have the bill protested for better security. For this purpose, the notary public is employed to demand better security and on its refusal protest may be made within a reasonable time. This is called a "Protest for Better Security." It may be observed that the acceptor is not bound to give such security, nor can the holder sue the drawer, and the endorsers before maturity of the bill in spite of the protest. The advantage of protest for better security, in addition to the fact being placed on record for the information of the drawer and the endorsers, is that it enables the bill to be accepted for honor.

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Contents of Protest (Sec. 101)

A protest to be valid, must contain the particulars given below, and the omission of one or more of them will render the protest invalid. The particulars that a protest must

contain are:—

1. The instrument itself, or a literal transcript thereof.

2. The names of the parties for and against whom the instrument has been protested.

3. The fact and reasons for dishonor.

4. Place and time of dishonor or refusal to give better security.

5. The signature of the notary public.

6. In the event of an acceptance for honor or ...

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