Negotiable Instruments

ABSTRACT

Although every business uses negotiable instrument in one way or other but very few individual understand the overall scope and facts about these instruments. Negotiable instrument is an unconditional order or promise to pay an amount of money, easily transferable from one person to another. Negotiable Instruments have their origin in centuries past where they were developed as an alternative to the risk of carrying gold or money from market town to market town. Hence we have decided to write all the relevant material and information from various sources and rewrite according to need of the readers. So we all may be able to understand the meaning of negotiable instruments; identify the various features of negotiable instruments; describe the various types of negotiable instruments; and differentiate between bills of exchange, promissory notes, and cheques.

Law of Negotiable Instruments 1881

1. Introduction:
Exchange of goods and services is the basis of every business activity. Goods are bought and sold for cash as well as on credit. All these transactions require flow of cash either immediately or after a certain time. In modern business, large number of transactions involving huge sums of money takes place everyday.

It is quite inconvenient as well as risky for either party to make and receive payments in cash. Therefore, it is a common practice for businessmen to make use of certain documents as means of making payment. Some of these documents are called negotiable instruments.

According to section 13 of the Negotiable Instruments Act, 1881, a negotiable instrument means “promissory note, bill of exchange, or cheque, payable either to order or to bearer”.

A NEGOTIABLE INSTRUMENT is a document that meets the requirements for circulation without reference to other sources. The amount must be clearly specified or capable of being calculated.

➢ Therefore Negotiable Instrument Act, 1881 or Law of Negotiable Instrument, 1881 has been constituted to help individual in their daily business activity.

➢ The main object of the Negotiable Instruments Act is to legalize the system by which instruments contemplated by it could pass from hand to hand by negotiation like any other goods.

➢ The purpose of the Act was to present an orderly and authoritative statement of leading rules of law relating to the negotiable instruments.

➢ To achieve the objective of the Act, the Legislature thought it proper to make provision in the Act for conferring certain privileges to the business instruments contemplated under it and provide special procedure in case the obligation under the instrument was not discharged.

2. Meaning of Negotiable Instruments
To understand the meaning of negotiable instruments let us take a few examples of day-to-day business transactions.

Suppose Ali a distributor has sold chemicals to Ahmed for Rs 65,000/ on three months credit. To be sure that Ahmed will pay the money after three months, Ali may write an order addressed to Ahmed that he is to pay after three months, for value of goods received by him, Rs.65,000/ to Ali or anyone holding the order and presenting it before Ahmed for payment.
This written document has to be signed by Ahmed to show his acceptance of the order. Now, Ali can hold the document with him for three months and on the due date can collect the money from Ahmed. He can also use it for meeting different business transactions. For instance, after a month, if required, he can borrow money from Tariq for a period of two months and pass on this document to Tariq. He has to write on the back of the document an instruction to Ahmed to pay money to Tariq, and sign it.
Now Tariq becomes the owner of this document and he can claim money from Ahmed on the due date. Tariq, if required, can further pass on the document to Malik after instructing and signing on the back of the document. This passing on process may continue further till the final payment is made.
In the above example, Ahmed who has bought chemical worth Rs. 65,000/ can also give an undertaking stating that after three month he will pay the amount to Ali.
Now Ali can retain that document with himself till the end of three months or pass it on to others for meeting certain business obligation (like with Tariq) before the expiry of that three months time period.

You must have heard about a cheque. What is it? It is a document issued to a bank that entitles the person whose name it bears to claim the amount mentioned in the cheque. If he wants, he can transfer it in favor of another person. For example, if Saeed issues a cheque worth Rs. 30,000/ in favor of Umer, then Umer can claim Rs. 30,000/ from the bank, or he can transfer it to Aziz to meet any business obligation, like paying back a loan that he might have taken from Aziz. Once he does it, Aziz gets a right to Rs. 30,000/- and he can transfer it to Talha, if required. Such transfers may continue till the payment is finally made to somebody.

In the above examples, we find that there are certain documents used for payment in business transactions and are transferred freely from one person to another. Such documents are called Negotiable Instruments. Thus, we can say negotiable instrument is a transferable document, where negotiable means transferable and instrument means document. To elaborate it further, an instrument, as mentioned here, is a document used as a means for making some payment and it is negotiable i.e., its ownership can be easily transferred.
Thus, negotiable instruments are documents meant for making payments, the ownership of which can be transferred from one person to another many times before the final payment is made.

3. Types of Negotiable Instruments
According to the Negotiable Instruments Act, 1881 there are just three types of negotiable instruments i.e., promissory note, bill of exchange and cheque.

However many other documents are also recognized as negotiable instruments on the basis of custom and usage, like treasury bills, share warrants, etc, provided they possess the features of negotiability.

In the following sections, we shall study about Promissory Notes popularly called pro-notes, Bills of Exchange popularly called bills, Cheques and Hundis a popular indigenous document prevalent in Pakistan. The rules are very similar to the United Kingdom’s, Canada’s, America’s, India’s & Pakistan’s.

Negotiable Instruments have their origin in centuries past where they were developed as an alternative to the risk of carrying gold or money from market town to market town
They represent “money’s worth” and are considered almost good as gold.

3 Promissory Note
Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as ‘an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument’.

➢ For example: Suppose you take a loan of Rupees Five Thousand from your friend Mohsin. You can make a document stating that you will pay the money to Mohsin or the bearer on demand. Or you can mention in the document that you would like to pay the amount after three months. This document, once signed by you, duly stamped and handed over to Mohsin, becomes a negotiable instrument. Now Mohsin can personally present it before you for payment or give this document to some other person to collect money on his behalf. He can endorse it in somebody else’s name who in turn can endorse it further till the final payment is made by you to whosoever presents it before you. This type of a document is called a Promissory Note or Pro-Note.

[pic] 3 Parties to a Promissory Note
There are primarily two parties involved in a promissory note. They are I. The Maker or Drawer – the person who makes the note and promises to pay the amount stated therein. In the above specimen, Tariq is the maker or drawer. II. The Payee – the person to whom the amount is payable. In the above specimen it is Mohsin.
In course of transfer of a promissory note by payee and others, the parties involved may be -
a) The Endorser – the person who endorses the note in favor of another person. In the above specimen if Mohsin endorses it in favor of Ejaz and Ejaz also endorses it in favor of Muneeb, then Mohsin and Ejaz both are endorsers.
b) The Endorsee – the person in whose favor the note is negotiated by endorsement. In the above, it is Ejaz and then Muneeb.

3 Features of a promissory note
Let us know the features of a promissory note.
1) A promissory note must be in writing, duly signed by its maker and properly stamped as per Pakistan Stamp Act.
2) It must contain an undertaking or promise to pay. Mere acknowledgement of indebtedness is not enough. For example, if some one writes ‘I owe Rs. 5000/- to Mohsin Javeed, it is not a promissory note.
3) The promise to pay must not be conditional. For example, if it is written ‘I promise to pay Mohsin Rs 5,000/- after my sister’s marriage’, is not a promissory note.
4) It must contain a promise to pay money only. For example, if some one writes ‘I promise to give Ali a Suzuki car’ it is not a promissory note.
5) The parties to a promissory note, i.e. the maker and the payee must be certain.
6) A promissory note may be payable on demand or after a certain date. For example, if it is written ‘three months after date I promise to pay Mohsin or order a sum of rupees Five Thousand only’ it is a promissory note.
7) The sum payable mentioned must be certain or capable of being made certain. It means that the sum payable may be in figures or may be such that it can be calculated. (See specimen below).

[pic] 3 Bill of Exchange
Section 5 of the Negotiable Instruments Act, 1881 defines a bill of exchange as ‘an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to or to the order of a certain person, or to the bearer of the instrument’.

➢ For Example:
Suppose Malik has given a loan of Rupees Ten Thousand to Samie, which Samie has to return. Now, Malik also has to give some money to Abuzar. In this case, Malik can make a document directing Samie to make payment up to Rupees Ten Thousand to Abuzar on demand or after expiry of a specified period.
This document is called a Bill of Exchange, which can be transferred to some other person’s name by Abuzar.

[pic]

3 Parties to a Bill of Exchange
There are three parties involved in a bill of exchange. They are I. The Drawer – The person who makes the order for making payment. In the above specimen, Malik is the drawer. II. The Drawee – The person to whom the order to pay is made. He is generally a debtor of the drawer. It is Samie in this case. III. The Payee – The person to whom the payment is to be made. In this case it is Abuzar.

The drawer can also draw a bill in his own name thereby he himself becomes the payee. Here the words in the bill would be “Pay to us or order”. In a bill where a time period is mentioned, just like the above specimen, is called a Time Bill. But a bill may be made payable on demand also. This is called a “Demand Bill”.

3 Features of a bill of exchange
Let us know the various features of a bill of exchange.
1) A bill must be in writing, duly signed by its drawer, accepted by its drawee and properly stamped as per Pakistan Stamp Act.
2) It must contain an order to pay. Words like ‘please pay Rs 10,000/- on demand and oblige’ are not used.
3) The order must be unconditional.
4) The order must be to pay money and money alone.
5) The sum payable mentioned must be certain or capable of being made certain.
6) The parties to a bill must be certain.
7) Under the Bills of Exchange Act, it is not fatal that the Bill is not dated nor has no fixed time for acceptance or if there is no mention of the amount.
8) If not dated, the bill must at least have the due date. A date may be added at a later time.

3 Liability of the Parties to a Bill of Exchange

❖ Acceptance of a bill of exchange by a drawee makes the drawee liable to pay the bill at the place and date fixed for payment, or in the case of a demand bill, at a reasonable time thereafter. ❖ The bill MUST be presented by the holder or his authorized representative at a reasonable hour on a business day at the place specified in the bill. ❖ Once payment is made, the holder must turn the bill over to the acceptor for cancellation or destruction. ❖ If a bill is dishonored by non-payment, the holder may hold the drawer, acceptor and any endorsers liable on the bill. ❖ However, in order to confirm this liability, the holder must give an opportunity to each of them to pay the bill by giving each of them notices of dishonors. ❖ To be valid, notice has to be given no later than the next business day after the date of dishonor. ❖ The notice may be either in writing or by telephone but must i. identify the bill ii. indicate that the bill has been dishonored ❖ Notice of dishonor may be dispensed with this is sometimes indicated right on the bill.

3 Cheques
The Negotiable Instruments Act, 1881 defines a cheque as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. Actually, a cheque is an order by the account holder of the bank directing his banker to pay on demand, the specified amount, to or to the order of the person named therein or to the bearer.
Cheque is a very common form of negotiable instrument. If you have a savings bank account or current account in a bank, you can issue a cheque in your own name or in favor of others, thereby directing the bank to pay the specified amount to the person named in the cheque.
Therefore, a cheque may be regarded as a bill of exchange; the only difference is that the bank is always the drawee in case of a cheque.

[pic]

3 Features of a cheque
Let us look into some important features of a cheque.
1) A cheque must be in writing and duly signed by the drawer.
2) It contains an unconditional order.
3) It is issued on a specified banker only.
4) The amount specified is always certain and must be clearly mentioned both in figures and words.
5) The payee is always certain.
6) It is always payable on demand.
7) The cheque must bear a date otherwise it is invalid and shall not be honored by the bank. 3 Types of Cheque
Broadly speaking, cheques are of four types.
a) Open cheque.
b) Crossed cheque.
c) Bearer cheque
d) Order cheque

a) Open cheque: A cheque is called ‘Open’ when it is possible to get cash over the counter at the bank. The holder of an open cheque can do the following: ➢ Receive its payment over the counter at the bank, ➢ Deposit the cheque in his own account ➢ Pass it to some one else by signing on the back of a cheque. b) Crossed cheque: Since open cheque is subject to risk of theft, it is dangerous to issue such cheques. This risk can be avoided by issuing another type of cheque called ‘Crossed cheque’. The payment of such cheque is not made over the counter at the bank. It is only credited to the bank account of the payee. A cheque can be crossed by drawing two transverse parallel lines across the cheque, with or without the writing ‘Account payee’ or ‘Not Negotiable’. c) Bearer cheque: A cheque which is payable to any person who presents it for payment at the bank counter is called ‘Bearer cheque’. A bearer cheque can be transferred by mere delivery and requires no endorsement. d) Order cheque: An order cheque is one which is payable to a particular person. In such a cheque the word ‘bearer’ may be cut out or cancelled and the word ‘order’ may be written. The payee can transfer an order cheque to someone else by signing his or her name on the back of it.

4 Features of Negotiable Instruments
After discussing the various types of negotiable instruments let us sum up their features.

❖ A negotiable instrument is freely transferable. Usually, when we transfer any property to somebody, we are required to make a transfer deed, get it registered, pay stamp duty, etc. But, such formalities are not required while transferring a negotiable instrument. The ownership is changed by mere delivery when payable to the bearer or by valid endorsement and delivery when payable to order. Further, while transferring it is also not required to give a notice to the previous holder.

❖ Negotiability confers absolute and good title on the transferee. It means that a person who receives a negotiable instrument has a clear and undisputable title to the instrument. However, the title of the receiver will be absolute, only if he has got the instrument in good faith and for a consideration. Also the receiver should have no knowledge of the previous holder having any defect in his title. Such a person is known as holder in due course.

For example: Suppose Malik issued a bearer cheque payable to Hussain. It was stolen from Hussain by a person, who passed it on to Muneeb. If Muneeb received it in good faith and for value and without knowledge of cheque having been stolen, he will be entitled to receive the amount of the cheque. Here Muneeb will be regarded as ‘holder in due course’.

❖ A negotiable instrument must be in writing. This includes handwriting, typing, computer print out and engraving, etc.

❖ In every negotiable instrument there must be an unconditional order or promise for payment.

❖ The instrument must involve payment of a certain sum of money only and nothing else. For example, one cannot make a promissory note on assets, securities, or goods.

❖ The time of payment must be certain. It means that the instrument must be payable at a time which is certain to arrive. If the time is mentioned as ‘when convenient’ it is not a negotiable instrument. However, if the time of payment is linked to the death of a person, it is nevertheless a negotiable instrument as death is certain, though the time thereof is not.

❖ The payee must be a certain person. It means that the person in whose favor the instrument is made must be named or described with reasonable certainty. The term ‘person’ includes individual, body corporate, trade unions, even secretary, director or chairman of an institution. The payee can also be more than one person.

❖ A negotiable instrument must bear the signature of its maker. Without the signature of the drawer or the maker, the instrument shall not be a valid one.

❖ Delivery of the instrument is essential. Any negotiable instrument like a cheque or a promissory note is not complete till it is delivered to its payee. For example, you may issue a cheque in your brother’s name but it is not a negotiable instrument till it is given to your brother.

❖ Stamping of Bills of Exchange and Promissory Notes is mandatory. This is required as per the Indian Stamp Act, 1899. The value of stamp depends upon the value of the pro-note or bill and the time of their payment.

5 Various Court Cases invoking Negotiable Instrument Act
Now we can take a look at various court cases regarding negotiable instrument. These cases can fully explain to us how the Negotiable Instrument Act is explained and enforced by the courts.

1) Spouses Eduardo and Epifania Evangelista vs. Mercator Financing Co. (GR No 148864, Aug 21, 2003, Puno)

The promissory not in question is worded as follows:

“For value received, I/we jointly and severally promise to pay to the order of Mercator Financing Company ……..”

Issue: Are the spouses jointly and severally liable?

Held: The SC held that under Section 17 (g) of the NIL and Article 1216 of the Civil Code, where the promissory note was executed jointly and severally by two or more persons, the payee of the promissory note had the right to hold any one of the two (2) signers of the promissory note responsible for the payment of the whole amount of the note.

2) Samsung Construction Company Phils., Inc vs. FEBTC (GR No 129015, Aug 13, 2004, Tinga)

Facts: Petitioner maintains a current account with the respondent bank. The petitioner authorized Jong to sign checks in behalf of the company. The checks are in the custody of an accountant Kyu. On one occasion, a certain Gonzaga presented a check to FEBTC purportedly drawn by the Company in the amount of P 999,500. The check was payable to cash and appeared to be signed by Jong. FEBTC upon ascertaining that there are sufficient fund to cover the check and finding the signature of Jong appears to be genuine paid Gonzaga. Later, the forgery was discovered. Samsung demanded that the amount paid to Gonzaga be credited back to its account because they have not authorized the encashment of the check. On the other hand, the respondent bank claimed negligence on the part of the petitioner in protecting its check.

Issue: Who should bear the loss?

Held: The SC held that the FEBTC should bear the loss. Under Sec. 62 of NIL, among the warranties to be assumed by the acceptor is it admits the existence of the drawer, the genuineness of his signature, and his capacity and authority to draw the instrument. It is incumbent upon the drawee bank to ascertain the genuineness of the signature of its depositor. The respondent bank in this case did not exercise the degree of diligence required to enable it to detect the forgery.

Addendum: ***Aside from the warranties as an endorsers, the collecting bank is made liable because it is privy to the depositor who negotiated the check because it knows him, his address and history for being a client thereof. Thus, it is in a better position to detect forgery or irregularity in the endorsement. (Associated bank v. CA, 252 SCRA 620). aka “Doctrine of Comparative Negligence”

3) Ilusorio vs CA (GR No 139130, Nov 27, 2004)

Facts: The petitioner maintains a current account with Manila Banking Corp. He entrusts his checkbook and credit cards to his secretary. During the period 1980-81, his secretary was able to encash a total of 17 checks drawn against Manila Banking Corp. Ilusorio discovered these checks upon examination of his bank statements forwarded by the bank. And upon investigation, it was found out that his signatures were forged by his secretary on those 17 checks. Ilusorio demanded the return of amount by the drawee bank. The drawee bank contended negligence on the part of the petitioner.

Issue: Who should suffer the loss?

Held: The SC held that Ilusorio was negligent. While it may be true that the signature of Ilusorio was forged by his secretary and that he did not authorized the encashment of these checks claiming real defense of forgery on his part, Ilusorio’s previous conduct effectively precluded him from claiming forgery as a defense. The mere fact that these checks have been encashed for a period of almost two years, the petitioner should have detected the forgery. Further, the unusual degree of trust which he had accorded his secretary, such as unrestricted access to his credit cards and checkbooks amounts to negligence on his part and the proximate loss of his funds is attributable to this unusual degree of trust and confidence which he reposed to his secretary.

Therefore: General Rule – drawee bank bears the loss because of Sec 62 of NIL. Exception – Ilusorio case (negligence on the part of the drawer)

Addendum: Question: 1. How about if it is the signature of the endorser which is forged? Is the drawee bank still liable? 2. How about if the drawee bank has already paid the holder when it discovered the forged endorsement of the payee? Who bears the loss?

Answer: No. The drawee bank should not be made liable. The collecting bank or last endorser generally suffers the loss because it has the duty to ascertain the genuineness of all prior endorsements considering that the act of presenting the check for payment to the drawee is an assertion that the party making the presentment has done its duty to ascertain the genuineness of the endorsements. As between the drawer and the drawee bank, the drawee bank should bear the loss. The drawee bank shall have recourse against the collecting bank because such collecting bank guarantees that all prior endorsements are genuine. The collecting bank then can go against the forger.

In cases involving a forged check, where the drawer’s is forged, drawer can recover from the drawee bank. No drawee bank has a right to pay a forged check. If it does, it shall have to re-credit the amount of check to the account of the drawer. The liability chain ends with drawee bank whose responsibility it is to know the drawer’s signature since the latter is its customer. (Associated Bank vs CA, 252 SCRA 620). The endorser is liable on the instrument although the signature of the payee is forged because the endorser by his endorsement guaranteed that the instrument is genuine, therefore, impliedly, that the instrument is valid, otherwise, there would be nothing for the endorser to guarantee. (Republic vs Ebrada 65 SCRA 680).

6 Conclusion
Negotiable instruments in the form of bills of exchange, promissory notes and cheques are governed by the Negotiable Instruments Law, 1881. Each of these instruments was developed to meet the particular needs of Businessmen or any other individuals.
To be negotiable, an instrument must possess certain essential elements for negotiability. The instrument must be an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay, on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person or to bearer or to a specific person
If it meets these requirements, it may be negotiated by the holder to any other by way of delivery. The endorsement renders the person making the endorsement liable to the holder in the event that the instrument is subsequently dishonored.
A holder acquires greater rights under a negotiable instrument than an ordinary assignee of a contractual right. A holder in due course is generally entitled to claim payment even if there is a defect in title in the instrument.
The only defence against a holder in due course is what is called real defences such as forgery, incapacity of a minor and others that may render the instrument a nullity.