A negotiable instrument is a written contract that guarantees the benefit from one person to another. In other words, it is a transferable, signed document that promises the bearer a sum of money in the future when demanded. The person who receives the payment is called a payee and he must be named or otherwise indicated on the instrument.
Features of Negotiable Instruments
Easily Transferable: A negotiable instrument is easy and free to transfer. This transfer involves no formalities or much paperwork. The instrument's owner can simply transfer through delivery or through a valid endorsement.
Must be in Writing: All negotiable instruments must be in the written format that should consist of handwritten notes, printed, engraved, typed, etc.
Time of Payment Must be Certain: If the order is flexible to payment time then such an order is not considered as a negotiable instrument. There should be a certain period even if there is not a specific date. For example, If the time of payment depends on the death of a specific individual, it is considered as a negotiable instrument, as death is a specific event.
Payee also must be Certain: The person who receives the payment must be a specific person or persons. There can also be more than one payee for a negotiable instrument. “Person” in this case includes artificial persons such as body corporates, trade unions, chairman, secretary, etc.
Types of Negotiable Instruments
Promissory Note: Where, the person who makes the instrument is called a debtor. The debtor unconditionally promises the creditor (or the bearer) a certain sum of money in a specific period.
Bills of Exchange: Where the instrument instructs the drawee (the debtor) to pay the payee for a certain amount of money. The drawer (the creditor) prepares the bill.
Cheque: This is a bill of exchange where the bank is a creditor and the cheque is payable only on demand. Where the depositor instructs the bank to pay the payee or the bearer a certain amount of money denoted in the cheque.
Other Negotiable Instruments Examples: Government promissory notes, railway receipts, delivery orders, are some of the examples of other negotiable instruments. By custom or practice of the trade, these are negotiable instruments.
Advantages of Negotiable Instruments
In the Case of the Promissory Note:
It is simple and easy to understand.
It is extremely beneficial if the loan has simple payment terms.
This type of instrument is not very lengthy.
In the Bill of Exchange:
It can be transferred easily.
If the loan has simple payment methods it will be extremely beneficial.
It is not so lengthy.
They are certain of terms and conditions. It is one of the convenient means of crediting policies.
In the Case of Payment Cheque:
It is more convenient than carrying cash in hand.
The depositor can stop the payment, if necessary
It Can be post-dated
FAQs on Introduction to Negotiable Instruments
1. What is a negotiable instrument in simple terms?
A negotiable instrument is a signed document that promises a specific sum of money to a specified person or the bearer. As per the Negotiable Instruments Act, 1881, it is a written contract that is freely transferable from one person to another, either by simple delivery or by endorsement and delivery. Think of it as a formal IOU that can be passed on. Common examples include cheques, promissory notes, and bills of exchange.
2. What are the essential characteristics of a negotiable instrument?
For a document to be considered a negotiable instrument, it must have the following features:
- Written and Signed: The instrument must be in writing and signed by the person who creates it (the maker or drawer).
- Unconditional Promise or Order: It must contain an unconditional promise (like in a promissory note) or an unconditional order (like in a bill of exchange or cheque) to pay.
- Certain Sum of Money: The amount payable must be a specific, certain sum of money.
- Freely Transferable: It can be transferred from one person to another without any legal formalities.
- Title of Holder: The person who receives the instrument in good faith (a 'holder in due course') gets a better title, free from any defects in the title of the transferor.
3. What are the three main types of negotiable instruments recognised in the CBSE syllabus?
The three principal types of negotiable instruments covered under the Negotiable Instruments Act, 1881, are:
- Promissory Note: A written promise made by one person (the maker) to pay a certain sum of money to another person (the payee).
- Bill of Exchange: A written order from one person (the drawer) to another (the drawee), directing them to pay a certain sum of money to a third person (the payee) or to the drawer's order.
- Cheque: A specific type of bill of exchange that is always drawn on a specified banker and is payable on demand.
4. What is the role of the Negotiable Instruments Act, 1881?
The Negotiable Instruments Act, 1881 is the primary legislation in India that governs the use of promissory notes, bills of exchange, and cheques. Its main role is to provide a uniform legal framework for these instruments, which are crucial for trade and commerce. It defines each instrument, outlines the rights and liabilities of the parties involved, and provides legal procedures for enforcement and in case of dishonour (e.g., a bounced cheque).
5. How does a Bill of Exchange differ from a Promissory Note?
While both are credit instruments, a Bill of Exchange and a Promissory Note differ in key aspects:
- Nature: A Bill of Exchange is an order to pay, whereas a Promissory Note is a promise to pay.
- Parties: A Bill of Exchange involves three parties (Drawer, Drawee, Payee), while a Promissory Note has only two (Maker, Payee).
- Creator: A Bill of Exchange is drawn by the creditor (seller), while a Promissory Note is made by the debtor (buyer).
- Acceptance: A Bill of Exchange generally requires acceptance by the drawee to be valid. A Promissory Note does not require any acceptance as it is a promise made by the debtor himself.
6. Why is the feature of 'negotiability' so important for business transactions?
The feature of 'negotiability' is crucial because it allows these instruments to function as a substitute for money. It means the instrument can be transferred freely and easily from one person to another to settle debts. This transferability provides liquidity in the market, allowing businesses to continue their operations by using credit instruments instead of relying solely on physical cash for every transaction. It forms the bedrock of modern commerce.
7. In what business situations is a Bill of Exchange more suitable than a Cheque?
A Bill of Exchange is primarily used for credit transactions where payment is to be made at a future date. For example, a seller (creditor) sells goods to a buyer (debtor) on a 60-day credit. The seller can draw a bill of exchange on the buyer, who accepts it, making it a legally enforceable promise to pay after 60 days. In contrast, a Cheque is used for making immediate payments from a bank account and is not suitable for formalising a future credit period.
8. What is an 'inchoate instrument' and is it legally valid?
An 'inchoate instrument' refers to a document that is signed and stamped as per the law but is left incomplete in some way, for example, the amount or payee's name is not filled in. According to Section 20 of the NI Act, 1881, the person who signs and delivers this document gives authority to the holder to complete it. Once completed, it becomes a valid negotiable instrument, and the signer is liable for the amount filled in, provided it is within the amount covered by the stamp.
