In our day-to-day life, we come across several transactions which involve the exchange of money for goods or services. Money, as a medium of exchange, may exist in several forms, such as currency, cheques, bonds, promissory notes etc. All such forms of money, apart from currency, are considered instruments of exchange, for the simple reason that they are a medium of exchange, just not in the conventional form i.e. in the form of currency notes and coins. Usually, large business transactions and exchange of goods or services in bulk cannot be carried out if money were to exist only in the form of currency, because paying such huge amounts of money through notes and coins would be impracticable. Thus, with the development of economies and businesses, money came to exist in other forms, such as cheques and bills, which made exchange easier and more authentic.
These very instruments of exchange are labeled as negotiable instruments. They are authentic documents that guarantee payments of money to another person, whether immediately or on a future date, and usually come with a contract mentioning that the payment is done unconditionally, as well as setting out further formalities and details. A negotiable instrument is a term widely used in businesses and business laws, and it can have distinct meanings depending upon the jurisdiction in which it is used.
Concept of Negotiable Instruments
Before moving to the Characteristics of Negotiable Instruments, first we need to understand the concept of Negotiable Instruments. A document which pays or promises to pay the assignee a specified sum of money either on demand or on a future date, after which the assignee holds full title to that document, is called a negotiable instrument. Negotiable instruments are sometimes in the form of contracts which are transferable from one person to another.
In India, negotiable instrument is defined under Section 13 of the Negotiable Instruments Act, 1881. It says that a negotiable instrument means a promissory note, a bill of exchange, or a cheque which is payable either to the bearer or to order. The term ‘negotiable’ signifies that the document is transferable to a different party or parties.
Negotiable instruments allow their holders to obtain funds in the form of cash or to transfer them to another person. They contain details of the amount to be transferred, the interest rate of any, the person to whom the payment is being made as well as the person making the payment, date, verification through signature etc. For example, a bank cheque is a form of negotiable instrument, where the person making the payment fills in the name of the person to which the payment is being made, the amount payable in words as well as numbers, and the date on which the payment is or will be made, and his signature.
Types of Negotiable Instruments
There are various types of negotiable instruments depending upon the nature of transaction.
A promissory note is a document which contains a promise of payment of money from one person to another on a specified date and time in the future. A promissory note may be non-negotiable in certain cases, but if it is unconditional, then it is negotiable. It contains the amount to be paid along with any interest, on a pre-decided date, and is signed by the payer. Bank notes are a form of promissory notes, but section 4 of the Negotiable Instruments Act defines a promissory note as other than a bank note or a currency note.
Illustration: A purchases goods from B of Rs. 1,00,000. A is not able to carry out the transaction in cash, so he issues a promissory note to B, promising to pay B the amount either when B demands it or on a future date.
Bill of Exchange
A bill of exchange is a well-known form of negotiable instrument, which is a written document instructing a party to make payment to another on a specified date or on demand. If a bill of exchange is issued by a financial institution, such as a bank, it is known as a bank draft, and when it is issued by an individual, it is known as a trade draft. A bill of exchange is commonly used in international trade transactions.
Illustration: A, an exporter, exports items worth Rs. 5,00,000 to B, and addresses a bill of exchange to B. C, a bank, will act as a guarantor for the payment made by B to A.
A cheque is also a common negotiable instrument, which is in the form of an unconditional order, signed by the payer, and is addresses to a bank from where the money will be transferred to the payee’s account. Even though the usage of cheques has been declining due to internet banking, a number of transactions such as payment of loans, bills, EMIs etc. are done through cheques.
The abovementioned instruments are negotiable instruments as per the Negotiable Instruments Act, 1881. Other instruments may include money orders, certificates of deposits, government promissory notes, hundies, railway receipts, traveller’s cheques, delivery orders etc.
Characteristics of Negotiable Instruments
Negotiable instruments come attached with certain features that define them further, as well as define the rights and liabilities of the person holding them. The Characteristics of Negotiable Instruments are as follows:
(1) One of the most important characteristics of negotiable instruments are that of title. The person holding the instrument is considered to be the owner of that instrument, as well as of the property contained in it. This is a right that passes on from the person issuing the instrument to the bearer, or the receiver. It can also pass on through endorsement and delivery.
(2) One of the major reasons for issuing a negotiable instrument is that they are freely transferable, and do not require any condition to be fulfilled before the transfer.
(3) In case there is any legal defect in the title or property of such negotiable instrument, a person holding it in good faith, or a timely holder of such instrument holds so without any defects befalling him.
(4) In cases of legal defects ensuing upon a timely holder or a holder in due course, he can sue upon the negotiable instrument in his own name, thus making all the prior parties liable to him. Such a holder can recover all the amount of such an instrument.
(5) A holder in good faith who has not been a party to previous mala fide transactions, such as fraud, will not be affected by the defences which might be available to the parties prior to him.
(6) A negotiable instrument is payable either to order or to bearer, and an be paid on demand or at a specified time.
(7) Although a negotiable instrument does not create any obligation on part of the person making the payment, it does contain an obligation to secure the payment to the payee, and to authorize the holder to dispose the security. It may also direct the payer to waive any law that may benefit or protect a debtor.
A negotiable instrument facilitates prompt payment, that is why they are used widely. Also, payments are unconditional so the parties do not have to face any formalities before accepting or forwarding payments. Certain assumptions, such as a presumption of deliberation paid, are assumed as being fulfilled for all negotiable instruments. Ease in making transactions is one of the benefits of using negotiable instruments, because dishonour of payments affects all the parties connected to the transaction as well as ruins the credit. All in all, negotiable instruments are known for their transferability and financial worth.
FAQs on Characteristics of Negotiable Instruments
What is the most important feature of a negotiable instrument?
The most important characteristic of a negotiable instrument is that of title. The person holding the instrument is considered to be the owner of that instrument, as well as of the property contained in it. This is a right that passes on from the person issuing the instrument to the bearer, or the receiver. The holder can sue in his own name and recover the amount of the instrument in case of any legal anomalies.
How negotiable instruments are used in businesses?
Large business transactions and exchange of goods or services in bulk require the issuance of negotiable instruments instead of currency notes and coins because these instruments are authentic documents that guarantee payments of money to another person, whether immediately or on a future date, and usually come with a contract mentioning that the payment is done unconditionally, as well as setting out further formalities and details. Further, they are freely transferable and can be forwarded to the parties, which then become the owner of the property within the instrument.
What do negotiable instruments stand for?
Negotiable instruments are authentic documents that guarantee payments of money to another person, whether immediately or on a future date, and usually come with a contract mentioning that the payment is done unconditionally, as well as setting out further formalities and details.