Banking News

Legal aspects of negotiable instruments


The legal aspects of negotiable instruments, including cheque are provided under Negotiable Instrument Act 1881. Here we are on the lookout of some of the important sections dealing in negotiable instruments under the above act.

Who is the holder of an instrument?

A negotiable instrument including cheque payable to bearer can be negotiated by simple delivery of the instrument. The person to whom the bearer instrument is delivered becomes the holder of the instrument. In case of payable to order instruments, when the instrument is endorsed and delivered to endorsee, the endorsee becomes holder of the instrument.

The term “Holder “is defined under section 8 of N.I.Act 1881which is as under..

“The holder of a promissory note, bill of exchange or cheque means, any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. Where the note, bill or cheque is lost or destroyed its holder is the person so entitled at the time of such loss or destruction”

The definition implies that the person who claims to be holder should be entitled in his own name to the possession of the instrument and he has the right to receive or recover the amount thereon from the parties thereto. Another point to be noted from the definition is that physical possession is not required by section 8 of the act, it is sufficient that the holder is entitled the possession in his own name. In the other words, holder should have acquired the instrument in the capacity of payee or endorsee in a lawful manner. The person who received the instrument through forgery or by fraudulent method cannot be a holder.

The holder has the right to complete the blank endorsement into endorsement in full; he can cross an open cheque; he can add the word not negotiable to crossing. The holder has the right to obtain duplicate of a lost bill. However the drawer may insist for an indemnity from the holder against loss or damage on account of issuing a duplicate bill and holder has to give such indemnity to the drawer. The holder can negotiate a bill/instrument to third party provided the negotiation is expressly not prohibited.

What is the meaning of ‘Holder in due Course’?

Holder in due course is a person who takes a negotiable instrument for the value receivable by him in good faith and taken due care and caution while taking such instrument and he had no suspicion or reason to believe any defect existed in the title of the person, from whom he derived title possession of the instrument..

The term ‘holder in due course’ is defined in section 9 of N.I. Act, as under.

“Holder in due course means any person who for consideration became the possessor of a promissory note, bill of exchange or cheque, if payable to bearer, or the payee or indorsee thereof, if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.”

Thus a person claim to be a ‘holder in due course’ should satisfy the following conditions that (i) he must acquire the instrument for a consideration. (ii) The instrument acquired should be before it is matured for payment. An instrument payable on demand is treated as current, subject to it has not been in circulation for unreasonable length of time. It is most important that the holder in course had no cause to believe that any defect existed in the title of person from whom he has acquired the instrument. A person accepting an inchoate (incomplete) instrument cannot be a holder in due course. The instrument should be complete and regular while taking its possession. Forged signature conveys no title; as such there cannot be a holder in due course under forged endorsement.

What are the rights of Holder in due Course?

Section 36 of NI ACT1881 reads the rights of Holder in due course as under.

“Every prior party to a negotiable instrument is liable thereon to a holder in due course until the instrument is duly satisfied.”

Every prior party means the maker or drawer, the acceptor and intervening endorser.

Duly satisfied means if the liability of all the parties is extinguished and the instrument is discharged.

Difference between the rights of ‘Holder’ and ‘Holder in due course’

The difference between the rights of ‘Holder’ and ‘Holder in due course’ is that the holder in due course gets better title than the person from whom he acquired the title as he holds the instrument free from any defect of title of prior parties. For example a stolen cheque was negotiated by the thief to a transferee and the transferee satisfies the conditions of holder in due course. Here the holder (thief) does not have the right to claim from the maker or drawer whereas the holder in due course, who satisfies all the conditions to be a holder in due course, acquires a good title. The holder in course is empowered with the right to recover the money not only from the thief, but also from all prior parties like maker or drawer and any other prior endorsers. e.g. A payee (holder) was authorized by the drawer of the inchoate cheque to fill in certain amount for payment. But the payee/holder fills in, excess amount than the drawer has actually authorized him to fill in and negotiates it to another person (holder in due course). In this case the holder has filled the amount in excess of consideration amount; as such he cannot have legal recourse against the drawer. However the holder in due course has the right to receive full amount. He can sue both the drawer and payee to recover dues from them.

What is the meaning of ‘Payment in due course’?

Sec 10 of N.I Act 1881 provides that the payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof under circumstances which do not afford a reasonable ground for believing that he is not entitled to receive payment of the amount therein mentioned.

Definition of Endorsement

A signature of the owner (the holder of the instrument) would serve the legal rights to transfer an instrument to another party. When holder signs the instrument with an intention to negotiate it, it is called endorsement. Thus a simple signature of the holder without any additional word constitutes an endorsement.

Section 15 of N.I.Act  1881, defines endorsement as under.

“When the maker or holder of a negotiable instrument signs the same, otherwise than as such maker, for the purpose of negotiation, on the back or face thereof or on slip of paper annexed thereto, or so sign for the same purpose a stamped paper intended to be completed as a negotiable instrument, he is said to indorse the same, and is called the indorser.”

Thus the endorsement must be written on the bill itself or any paper annexed to the bill (alongee) and be signed by the endorser. The negotiation of order instrument requires both endorsement and delivery of it to the endorsee. Therefore the endorsement is complete only after delivery of endorsed instrument to the endorsee. The endorsement confers the property in the instrument to the endorsee (transferee) with right of further negotiation

 Alongee:

 Since there is no restriction for number of endorsement, there may not be space available in the instrument itself for further endorsement. Therefore endorsement made on a slip of paper annexed to the instrument is called alongee. The endorsement written on alongee is deemed to be written on the instrument itself.

Whether a paying gets protection if the collecting banker credits the proceeds received by him to a person who is not the true owner of the instrument?

The section 85(1), 85(2),85(3) of negotiable instrument acts provide protection to paying banker respectively making payments of order cheque, bearer cheque or crossed cheque. However the paying banker does not get statutory protection if he makes the payment of a cheque which is materially altered or signature of the drawer is forged or payment made of a crossed cheque with an irregular endorsement. See, how the paying banker gets statutory protections.

Payment of order cheque

Section -85(1) of N.I.Act 1881 provides that

“Where a cheque payable to order purports to be endorsed by or on behalf of the payee, the drawee is discharged by payment in due course”

The above section provides protection to paying banker if he has made payment of a order cheque in due course (within the meaning of sec.10 of N.I.Act.) and if the proceeds credited to the account of an endorsee  if and only if the endorsement is regular.

Payment of bearer cheque

Section -85(2) of N.I.Act provides that

“Where a cheque is originally expressed to be payable to bearer, the drawee is discharged by payment in due course to the bearer thereof, notwithstanding any endorsement whether in full or blank appearing thereon and notwithstanding that any such endorsement purports to restrict or exclude further negotiation”. 

This section indicates that a cheque which is ‘once a bearer is always bearer’ (it means if a cheque which is originally issued as a bearer cheque remains always bearer). Therefore banks are not required to verify the regularity of the endorsement on the back of the cheque if any and they are protected from liability if they have made payment of a uncrossed bearer cheque to a bearer in due course.

What is the position of a banker upon payment of an instrument where alteration is not apparent?

Section 89 of N.I.Act 1881 deals with payment of instrument on which alteration is not apparent.  The section reads that “ Where a promissory note, bill of exchange or cheque has been materially altered but does not appear to have been so altered, or where a cheque is presented for payment which does not at the time of presentation appear to be crossed or to have had a crossing which has been obliterated, payment thereof by a person or banker liable to pay, and paying the same according to the apparent tenor thereof at the time of payment and otherwise in due course, shall discharge such a person or banker from all liability thereon, and such payment shall not be questioned by reason of the instrument having been altered, or the cheque crossed”.

Sec 89(2) provides that “Where the cheque is an electronic image of a truncated cheque, any difference in apparent tenor of such electronic image and the truncated cheque shall be a material alteration and it shall be the duty of the bank or the clearing house, as the case may be, to ensure the exactness of the apparent tenor of electronic image of the truncated cheque while truncating and transmitting the image.

Sec 89(3) provides that “Any bank or a clearing house which receives a transmitted electronic image of a truncated cheque, shall verify from the party who transmitted the image to it, that the image so transmitted to it and received by it, is exactly the same.

[Sub-clause 89(2) and 89(3) inserted vide Negotiable Instruments (Amendment and Miscellaneous Provisions) Act, 2002 ]

What is the meaning of a crossed generally or special or restrictive crossing?

Crossing of a Cheque

When two parallel transverse lines are appearing on the face of a cheque with or without the words “& Co.”, “Not Negotiable”, “A/c. Payee”, between the two parallel lines, it is called generally crossed cheque.  When a particular bank’s name is written in between the two parallel lines such a cheque is called specially crossed or restrictively crossed cheque. The payment of a generally crossed cheque cannot be made across the counter by cash payment and the payment proceeds should be credited to an account.

 Cheque crossed generally u/s 123 of N.I.act 1881 reads as under.

“Where a cheque bears across its face an addition of the words “and company” or any abbreviation thereof, between two parallel transverse lines, 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”.

Special or restrictive crossing

The Special or Restrictive Crossing on a cheque, makes it payable only to the banker whose name is written in the crossing. When the words Account Payee” or “Not negotiable appearing on the cheque, it is the responsibility of the collecting bankers to credit the proceeds to payees account only. There is no mention of Account Payee” in negotiable instruments act, but courts have upheld that “Account Payee” is a clear instruction to the paying banker to credit the proceeds to payee’s account only. Therefore the payment made to a collecting bank is subject to commitment made by collecting bank to paying bank that it would credit the proceeds collected, to the payee’s account only. The cheque marked ‘not negotiable’ to a crossed cheque does not bar it from transferred in the name of another person. However, a person who takes a cheque marked ‘not negotiable’ does not acquire better title than the person from whom he acquired the cheque. For example, a person takes a stolen cheque marked with ‘Not Negotiable’ from another person, then he is liable to refund encashed money to the true owner.

 

Section 124 of negotiable act 1881 defines the specially crossed cheque

“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”.

Whether the holder can cross the cheque?

Section 125 of N.I.Act 1881 permits the holder to cross the cheque after issue, which provides as under.

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.

Protection to paying banker for payment of ‘Crossed cheque’Section -128.of N.I.Act 1881 provides that“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 come to the hands of the payee) the drawer thereof shall respectively be entitled to the same rights, and be placed in if the amount of the cheque had been paid to and received by the true owner thereof”.

The above section provides protection to the paying banker if he has made the payment of a crossed cheque,  subject to following conditions.

  1. Payment made in due course (sec.10 of N.I.Act.).
  2.  Where a cheque is crossed generally, the banker on whom it is drawn shall not pay it otherwise than to a banker.
  3.  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.

In the following case a banker will be liable to true owner of the cheque

The banker who makes payment of a crossed cheque to a person otherwise than to the banker then he is liable for the loss to the true owner of the cheque.

The Section 129 of N.I.Act reads about bankers liability as under

“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.”

What is the effect of word “not negotiable” marked on the cheque?

The cheque marked ‘not negotiable’ to a crossed cheque does not bar it from transferred in the name of another person. However, a person who takes a cheque marked ‘not negotiable’ does not acquire better title than the person from whom he acquired the cheque. For example, a person takes a stolen cheque marked with ‘Not Negotiable’ from another person, then he is liable to refund encashed money to the true owner. Section 130 of Negotiable Act 1881  provides as under

“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.”

How a collecting banker gets the protection under N.I.Act?

 

Section 131 in The Negotiable Instruments Act, 1881 provides that.

“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.”

From the above section of N.I.act, we understand that the collecting banker is discharged from the liabilities to the true owner of a cheque or demand draft if the title to the instrument proves defective subject to following conditions.

  1. Cheque should be crossed one.
  2. He collected such cheque for a customer as an agent for collection and not as a holder for a value.
  3. He collected it in good faith and without negligence (Here ’good faith’ means banker had no reasonable ground to believe that the customer is not entitled to receive payment of the amount therein mentioned. ’Without negligence’ means the account of the customer on whose behalf cheque is collected, is opened with proper reference or introduction, and proceeds of the collected cheque is credited to only to the account of payee or to the account of endorsee if  endorsement on the instrument is regular.)

 

What is the effect of cheque returned for insufficient of funds?

 

If the cheque was returned for insufficiency of funds or exceeding amount arranged to be paid, it is a criminal offence under sec.138 of N.I Act punishable with imprisonment for a period up to one year or with fine which may extend to twice the amount of the Cheque. The drawer should ensure that sufficient balance is available in the account before issuing a cheque for payment.

Section 138 of negotiable instrument act 1881 [The Negotiable Instruments (Amendment And Miscellaneous Provisions) Act, 2002]

Where any cheque drawn by a person on an account  maintained  by  him  with a banker for payment of any amount of money  to  another  person  from  out of that account for the discharge, in  whole  or  in  part, of any debt or other liability, is returned by the bank  unpaid,  either  because of the amount of money standing to the credit of  that  account  is insufficient to honour the cheque or that it  exceeds  the  amount  arranged  to be paid from that account by an   agreement  made  with  that  bank,  such person shall be deemed to  have  committed  an  offence  and shall, without prejudice. to any other provision of  this  Act, be punished with imprisonment for a term which may extend to  two  years, or with fine which may extend to twice the amount of the cheque,  or with both: 

 Provided  that  nothing  contained in this  section  shall  apply  unless-

(a) the  cheque  has been, presented to the bank  within  a period  of six months from the date on which it is  drawn  or  within the period of its validity*, whichever is earlier;

(b) the payee or the holder in due course. of the cheque as the  case may be, makes a demand  for  the  payment  of  the said  amount of money by giving a notice, in writing,  to
the  drawer  of the cheque, within thirty days of the receipt  of information by him from the bank regarding the return of  the cheque as unpaid; and

 (c) the drawer of such cheque  fails to make the payment of the said amount of money to the payee or, as the case may be, to  the  holder in due course of the cheque,  within  fifteen  days of the receipt of the said notice.

From the above section of N.I.Act, we may infer that the cheque returned for the reason of ‘ insufficient fund’ or ‘exceeds arrangement’  is considered as criminal offence committed by the drawer of the cheque only if the cheque has been presented to the bank within the validity period of cheque (Validity of the cheque  is presently 3 months from the date of the cheque) and the payee or holder in due course gives the notice of dishonor in writing within 30 days of the receipt of information by him from the bank regarding the return of the cheque unpaid. The drawer of the cheque can escape from the punishment if he makes the payment of amount equivalent to  value of cheque to payee or holder in due case as the case may be.

 

No Comments

Leave a Reply

Your email address will not be published. Required fields are marked *


Comments

Latest Tweets

error: Content is protected !!

Sign up for our News Letter

We will let you know when new articles are posted on this site.

Privacy Policy. This information will never be shared.