Types Of Negotiable Instruments

The advent of modern business practices contributed to the growth of newer ways of facilitating financial transactions. Previously, cash was the most usual mode of exchanging goods and services for their value. The hike of negotiable instruments, however, brought radical changes in business practices.

Negotiable instruments are critical to our economy. They allow people to do business and to be sure that they will receive money for their services or goods without the actual transfer of cash. For example, a business can write a cheque to a supplier instead of delivering large amounts of cash. On a smaller scale, the same thing happens when you pay a bill to your electric company with a cheque rather than mailing cash. Without the predictable laws in place which can protect both the payor and payee of a negotiable instrument, our economy would not be able to function the way that it currently does.

All about Negotiable Instruments

The Negotiable Instruments (Amendment) Bill, 2017 has been introduced in the Lok Sabha on January 2nd, 2018.  The bill was for amending the existing Act. The bill includes the promissory note, bill of exchange, and cheques. The bill also states the penalties for the dishonour of cheques and various other violations related to negotiable instruments.

A negotiable instrument is a signed document that promises the payment of a specific amount of money to a specified person. The person receiving the payment is known as the payee and they are named on the instrument. In other words, a negotiable instrument is a promise of payment to the payee. Commonly used for conducting monetary dealings and commercial transactions, a negotiable instrument is a written document. The term ‘negotiable’ means transferable by delivery while instrument means a written document through which a right is created in favour of someone. Therefore, a negotiable instrument is a written document that is transferable by delivery.

In India, the Negotiable Instruments Act, 1881 is responsible for governing Negotiable Instruments. The Act does not define negotiable instruments clearly but it has provided an inclusive meaning for them.

Section 13(1) says Negotiable Instruments include promissory notes, bills of exchange or cheques payable either to order or to bearer. Hence, the Act only includes these three types of Negotiable Instruments within its ambit.

This law defines the instruments and also deals with each of them individually. There are other customary payment methods similar to Negotiable Instruments in India (like Hundis) but this law does not cover them.

Other modes of transactions can also be similar to Negotiable Instruments if they fulfill certain basic requirements. For example, any instrument can be a Negotiable Instrument if it is freely transferable by delivery or endorsement. Furthermore, it should possess certain rights, like the right of the holder to sue for it in his name.

According to the definition, an instrument of this kind must always possess the following characteristics:

  1. It should without any restriction be transferable either by simple delivery or by endorsement and delivery.
  2. Defects in the title of seller of these instruments do not affect the person who purchases them in good faith.
  3. Holder of these instruments can sue them in their names.

Different Types of Negotiable Instruments

According to the Negotiable Instruments Act, 1881 Section 13(i), a negotiable instrument can be of 3 different types:

  1. Promissory Note
  2. Cheques
  3. Bill of Exchange

Apart from these, there are some other types of instruments that have occupied the negotiability character because of the usage and custom of trade. These include:

  1. Exchequer bills
  2. Circular notes
  3. Share warrants
  4. Banknotes
  5. Dividend warrants
  6. Bearer debentures

1. Promissory Note

A promissory note stands for a written promise to its holder by an entity or an individual to pay a certain sum of money by a pre-decided date. In other words, Promissory notes reveal the amount which someone owes to you or you owe to someone together with the interest rate and also the date of payment. However, the seller isn’t bound to take the promissory note. The reputation of a buyer is of great importance to a seller in deciding whether to take the promissory note or not.

2. Bill of Exchange

Bills of exchange refer to a legally binding, written document which directs a party to pay a predetermined sum of money to the second(another) party. Some of the bills might express that money is due on a specified date in the future, or they might express that the payment is due on demand.

A bill of exchange is exercised in transactions of goods as well as services. It is signed by a party who owes money (called the payer) and given to a party entitled to acquire money (called the payee or seller), and thus, this could be used for fulfilling the contract for payment. However, a seller could also endorse a bill of exchange and give it to someone else, thus result in passing such payment to some other party.

When the bill of exchange is issued by the financial institution, it’s usually known as a bank draft. And if it is issued by an individual, it is usually known as a trade draft.

A bill of exchange essentially acts as a promissory note in the international trade; the exporter or seller, in the transaction addresses a bill of exchange to an importer or buyer. A third party, usually the banks, is a party to several bills of exchange playing as a guarantee for these payments. It helps in reducing any risk which is part and parcel of any transaction.

3. Cheque

A cheque is an instrument in writing which contains an unconditional order, addressed to a banker and is signed by a person who has deposited his money with the banker. This order needs the banker to pay a certain sum of money on demand only to the bearer of cheque (person holding the cheque) or to any other person who is to be paid as per instructions given.

Cheques could be a good method of paying different kinds of bills. Although the usage of cheques is declining over the years due to online banking, individuals still use cheques for paying for loans, college fees, car EMIs, etc.  Cheques are also a good method of keeping track of all the transactions on paper. On the other side, cheques are comparatively a slow way of payment and might take some time to be processed.

Effect of Negotiability

One of the most important principles relating to property transfers is ‘Nemo dat quad non-habet’. This maxim means nobody can pass a better title than that the person himself possesses.

In other words, one cannot transfer anything that does not belong to him in the first place. The effect of this rule is that any transfer without the transferor’s title is null and void.

Negotiable instruments are common exceptions to this very important rule requiring a proper title for transfers. Hence, a person may validly acquire Negotiable Instruments from a seller who does not possess a title over them. The only requirement of this exception is that the purchase of Negotiable Instruments must be for bona fide reason.

This article is authored by Sparsh Goyal, Fourth-Year, B.A.LL.B (Hons.) student at Vivekananda Institute of Professional Studies

Also Read – Negotiable Instruments Meaning, Basics, Types and Effects

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