What are the negotiable instruments?

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 every day. 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.

Evolution of negotiable instruments

Pastoral &
agriculture  Barter system
stage

Complex Handicraft
system, & guild  money as a
Confusion, stage medium of
slow exchange
growth

Domestic
& factory  growth of
stage economy &
commerce
 globalization

We came across the different stages through which trade and commerce went:

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 1. PASTORAL STAGE where business was limited and survival by breeding of
animals was the main motto. The first stage had to do nothing with money, people
lived a nomadic life.
2. However man learned quickly to grow food for their own need which can be
termed as the AGRICULTURAL STAGE. The demand increased for other
commodities as well and thus BARTER SYSTEM was introduced. This can be
termed as the turning point of trade and commerce.
3. After this man never looked back. They started producing specialized products
which led to the introduction of HANDICRAFT STAGE.
4. Then came the era in which people started to think about development and thus
formed groups to protect their rights, this was known as the GUILD STAGE.
5. Then came the stage where technology was introduced and business forms
became complex, this is where the necessity of introducing negotiable instruments
were felt.
This was known as the FACTORY STAGE

However it was noted that the growth was very slow and the system was very
complex. There were different instruments used to purchase different commodities in
different stages. The system of exchange was such that it led to confusion and various
complexities. To avoid such confusion and to operate the business activities smoothly
negotiable instruments were introduced.
Now as we have come across the term negotiable instruments and why it was
evolved, lets now have a brief knowledge about negotiable instrument.

Negotiable Instruments

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 Negotiable means “transferable.”

Instrument means “document.”

“Negotiable instrument, therefore, means a transferable document, signed by the
maker or drawer, and containing an unconditional promise to pay (or order to pay) a
certain sum of money on delivery, or at a definite time, to the bearer (or to the order).
The concept of negotiability is one of the most important features of commercial
paper.”

 The law relating to negotiable instruments is contained in the Negotiable

Instruments Act, 1881. The Act is based upon the English Common Law relating
to promissory notes, bills of exchange and cheques .The Act was enacted with an
object to define and modify the law relating to promissory notes, bills of exchange
and cheques.
 It is a document issued to a bank that allow 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 Amir issues a cheque worth Rs. 5,000/ - in favor of Buhran, then Buhran
can claim Rs. 5,000/- from the bank, or he can transfer it to Chand to meet any business
obligation, like paying back a loan that he might have taken from Chand. Once he does it,
Chand gets a right to Rs. 5,000/- and he can transfer it to Daniyal, 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.

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 CHARACTERISTICS OF NEGOTIABLE INSTRUMENTS

Property:
The possessor of the instrument is the holder and owner thereof. A
negotiable instrument does not only give possession of the
instrument, but right to property. Whosoever gets possession of the
instrument becomes its owner and is entitled to the sum mentioned
therein as the holder. The complete right of ownership in a
negotiable instrument passes by mere delivery where instrument is
payable to ‘bearer’. Where instrument is payable to ‘order’, right
of ownership passes by endorsement and delivery.
Defects in title:
The holder in good faith and for value called the ‘holder in due
course’ gets the instrument free from all defects of any previous
holder.

Freely transferable:

The property in a negotiable instrument passes from one person to

another by delivery, if the instrument is payable to bearer, and by
endorsement and delivery if it is payable to order.
Recovery:
The holder in due course can sue upon a negotiable instrument in
his own name for the recovery of the amount. Further he need not
give notice of transfer to the party liable on the instrument to pay

Remedy:
The holder can sue upon the negotiable instrument in his own
name. All prior parties are liable to him. A holder is due course can
recover the full amount on the instrument.
Rights:
The holder in due course is not affected by certain defenses which
might be available against previous holder, for example, fraud, to
which he is not a party.

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 Payable to order:
A promissory note, bill of exchange or cheque is payable to order
which is expressed to be so payable to a particular person. An
instrument which does not restricts its transferability expressly or
impliedly is negotiable whether the word ‘order’ is mentioned or
not. The word ‘Order’ or ‘Bearer’ is no longer necessary to
render an instrument negotiable. Where the instrument prohibits
transfer or indicates that it shall not be transferable is nevertheless
valid as between the parties thereto, but it is not a negotiable
instrument.
It must be noted that where a promissory note, bill of exchange or
cheque, either originally or by endorsement, is expressed to be
payable to the order of a specified person, and not to him or his
order, it is nevertheless payable to him or his order at his option.
Payable to bearer:
A promissory note, bill of exchange or cheque is payable to bearer
which is expressed to be so payable or on which the only or last
endorsement is an endorsement in blank [Sec.13]. It specifies that
the person in possession of the bill or note is a bearer of the
instrument which is so expressed payable to bearer.
Payment:
A negotiable instrument may be made payable to two or more
payees jointly, or it may be made payable in the alternative to one
or two, or some of several payees

Negotiation of commercial paper

Negotiation:

‘Negotiation’ means ‘transfer’

Negotiation gives special rights to the holder in due course. Transfer of a

negotiable instrument is affected in any one of the following two ways:

1. By negotiation

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 2. By assignment.

3. endorsement

 Transfer by negotiation is governed by the Negotiable Instruments

Act.

 Transfer by assignment is governed by the Transfer of Property Act.

 When the maker or holder signs the instrument on the back or the face of
it or on slip of paper called “Allonage” or signs stamp paper for that
purpose, he is said to have made a valid endorsement.

 Every sole maker, drawer, payee or endorser may endorse and negotiate
the instrument. Only a person who is a holder of instrument can endorse
and negotiate the instrument.

2. Kinds of Endorsements:
 There are seven kinds:

1. Endorsement in blanks:
If the endorsee signs his name only, the endorsement is said
to be blank or general endorsement.

2. Endorsement in full:
If the endorsee signs his name and address direction to pay
the amount mentioned in the instrument.

Types of negotiable instruments

Three types of negotiable instruments;

1. Promissory notes
2. Bill of exchange
3. Cheques

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 Promissory notes

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 “A promissory note is an instrument (not being a bank note or a currency-note) in
writing 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 instruments.”

Example:
Suppose you take a loan of Rupees Five Thousand from your friend Ramesh. You can
make a document stating that you will pay the money to Ramesh 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
Ramesh, becomes a negotiable instrument. Now Ramesh 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.

Illustration

Promissory Notes
1. “I promise to pay B or order Rs. 500.”
2. “I acknowledge myself to be indebted to B in Rs.1,000, to be paid on demand, for
value received.

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Not Promissory Notes
1. Mr. B, I.O.U. Rs. 1,000.
2. “I promise to pay B Rs, 500, and all other sums which shall be due to him.”
3. “I promise to pay B Rs. 500, first deducting thereout any money which he may owe
me,”
4. “I promise to pay B Rs. 500, seven days after my marriage with .“
5. “I promise to pay B Rs. 500 on D’s death provided D leaves me enough to pay that
sum’

Specimen of a Promissory Note

Rs. 10,000/- New Delhi

September 25, 2002
On demand, I promise to pay Ramesh, s/o RamLal of Meerut or order a sum of
Rs 10,000/- (Rupees Ten Thousand only), for value received.
To , Ramesh Sd/ Sanjeev
Address…….. Stamp

Parties to a Promissory Note

There are primarily two parties involved in a promissory note. They are

The Maker or Drawer:

The person who makes the note and promises to pay the amount
stated therein. In the above specimen, Sanjeev is the maker or
drawer.
The Payee:

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 “The person named in the instrument, to whom or to whose order
the money is, by the instrument directed to be paid, is called the
“payee”.
 In the above specimen it is Ramesh.

Essential Elements of promissory notes

Writing:
The promissory note must be in writing. Oral engagement or promise is
excluded. No particular form of words is necessary. It may be written in
ink or pencil or may even be printed or cyclostyled. It may be in any
form but the words shall be visible. Intentions to make a note should be
clear.

Undertaking to pay:
It is not necessary to use the word “Promise” but the intention
must clearly show an ‘unconditional undertaking’ to pay the
amount.

Unconditional:
It must contain definite and an unconditional undertaking to pay.
Promise to pay should be unconditional. A conditional instrument
is invalid. It must be certain of payment.

Signed:
The instrument must be signed by the maker thereof. The sign or a
mark would constitute signature, if the maker intended to subscribe
to the document. Person must sign with his free consent. It should
not only be a physical act but with an intention to sign.

Certain persons:
The maker and payee of the instrument must be certain and
definite persons. A note may be made by several persons jointly to
bind them jointly or severally. A promissory note cannot be made
by two person’s payable by either in the alternative.

Specific sum:

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 The sum promised to be paid must be certain and specific.

Promise to pay must be money only:

The promise to pay must be money only. Promise to pay anything
other than legal tender, in full or in part, is not a promissory note.

Stamping:
Promissory notes are chargeable with stamp duty. It is advisable to
cancel the stamps with maker’s signature or initials. An unstamped
or improperly or insufficiently stamped promissory note is not
admissible in evidence. No suit can be maintained upon an
unstamped or improperly stamped promissory note.

Reference:

 http://www.docstoc.com/docs/44136073/Introduction-to-
Money-and-Negotiable-Instruments
 http://www.scribd.com/doc/34792175/Negotiable-
Instruments
 http://www.blurtit.com/q807027.html
 http://www.scribd.com/doc/36798056/Negotiable-Instruments
 http://www.scribd.com/doc/27807638/Negotiable-Instruments
 http://www.blurtit.com/q807027.html

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