The Negotiable Instruments Act, 1881 is one of the most important commercial laws for bankers. It governs the law relating to negotiable instruments such as Promissory Notes, Bills of Exchange and Cheques. Since banks deal daily with cheques, bills and endorsements, knowledge of this Act is essential for banking operations as well as for examination purposes.
The Act came into force on 1 March 1882 and extends to the whole of India. Its objective is to facilitate trade and commerce by providing legal recognition and protection to certain instruments that are freely transferable.
Meaning of Negotiable Instrument
According to Section 13 of the NI Act, a negotiable instrument means:
“A promissory note, bill of exchange or cheque payable either to order or to bearer.”
A negotiable instrument is a written document which:
- Entitles one person to receive money from another, and
- Can be transferred from one person to another so that the transferee gets a clear title.
The special feature of a negotiable instrument is that a bona fide transferee for value gets a better title, even if the transferor’s title was defective.
Essential Characteristics of Negotiable Instruments
A negotiable instrument has certain basic features that make it different from ordinary contracts.
- It must be in writing
- It must contain an unconditional promise or order to pay
- The payment must be in money only
- The instrument must be transferable
- The transferee can sue in his own name
- A holder in due course gets a better title
These characteristics ensure easy circulation of money and smooth banking transactions.
Types of Negotiable Instruments under NI Act
The Act recognizes three main types of negotiable instruments:
- Promissory Note
- Bill of Exchange
- Cheque
Each of these has separate definitions and legal requirements.
Promissory Note
Meaning and Definition
As per Section 4 of the NI Act, a promissory note is:
“An instrument in writing containing an unconditional promise, 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.”
In simple words, it is a written promise by one person to pay money to another.
Essential Elements of a Promissory Note
For an instrument to be a valid promissory note, the following conditions must be satisfied:
- It must be in writing
- It must contain a clear and unconditional promise to pay
- It must be signed by the maker
- The amount must be certain
- The payee must be certain
- It must be payable in money only
A promissory note cannot be made payable to the maker himself.
Parties to a Promissory Note
- Maker: The person who makes the promise to pay
- Payee: The person to whom payment is to be made
In banking practice, promissory notes are commonly used in loan documentation.
Bill of Exchange
Meaning and Definition
According to Section 5 of the NI Act, a bill of exchange is:
“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.”
In a bill of exchange, there is an order to pay, not a promise.
Essential Elements of a Bill of Exchange
- It must be in writing
- It must contain an unconditional order to pay
- It must be signed by the drawer
- The parties must be certain
- The amount must be certain
- It must be payable in money only
Parties to a Bill of Exchange
A bill of exchange involves three parties:
- Drawer: The person who draws the bill
- Drawee: The person who is directed to pay
- Payee: The person who receives payment
In trade finance, bills of exchange are widely used in discounting and collection of bills.
Cheque
Meaning and Definition
As per Section 6 of the NI Act, a cheque is:
“A bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand.”
Thus, a cheque is a special type of bill of exchange.
Essential Features of a Cheque
- It must be in writing
- It must contain an unconditional order
- It must be drawn on a bank
- It must be payable on demand
- It must be signed by the drawer
- The amount must be certain
Parties to a Cheque
- Drawer: The account holder who issues the cheque
- Drawee: The bank
- Payee: The person receiving payment
Cheques are the most common negotiable instruments handled by banks.
Types of Cheques
Cheques can be classified in different ways based on usage and safety.
Bearer and Order Cheques
- Bearer Cheque: Payable to the person holding it
- Order Cheque: Payable to a specific person or his order
Crossed and Open Cheques
- Open Cheque: Can be encashed at the counter
- Crossed Cheque: Payment only through bank account
Crossing provides additional security and is widely encouraged by banks.
Holder and Holder in Due Course
Holder
A holder is a person entitled in his own name to the possession of the instrument and to receive payment.
Holder in Due Course (HDC)
A holder in due course is a person who:
- Acquires the instrument for consideration
- Before its maturity
- In good faith
- Without notice of any defect
The importance of HDC is very high in exams because:
- He gets a better title
- All prior parties are liable to him
Endorsement
Endorsement means signing the instrument for the purpose of transfer.
Types of Endorsement (important for exams)
- Blank endorsement
- Special endorsement
- Restrictive endorsement
- Conditional endorsement
Endorsement plays a major role in the transfer of cheques and bills.
Dishonour of Negotiable Instruments
When a negotiable instrument is not honoured on presentation, it is said to be dishonoured.
- Dishonour by non-acceptance (mainly bills)
- Dishonour by non-payment
Dishonour leads to legal consequences, especially in case of cheques.
Cheque Dishonour – Section 138
Section 138 of the NI Act deals with penalty for dishonour of cheque due to insufficiency of funds.
Conditions for applicability:
- Cheque must be issued for a legally enforceable debt
- It must be returned unpaid due to insufficient funds
- Notice must be given within 30 days
- Payment not made within 15 days
Punishment:
- Imprisonment up to 2 years
- Or fine up to twice the cheque amount
- Or both
This section is extremely important from both banking practice and exam point of view.
Importance of NI Act for Bankers
The Negotiable Instruments Act forms the legal backbone of banking operations. It ensures certainty, safety and trust in payment systems. Bankers must understand the provisions to avoid operational risks, legal disputes and financial losses.