Negotiable Instruments

Introduction to NI Act

Negotiability means transfer of an instrument from a person / entity to another person / entity. The transfer should be without restriction and in good faith. As per section 13 of the Negotiable Instruments Act, 1881, a negotiable instrument means a promissory note , bill of exchange  or a cheque , payable either to order or to bearer. Kindly note that a Currency Note is not a negotiable instrument as per section 21 of the Indian Currency Act .

Negotiable instruments covered under NI Act

Negotiable Instruments Act 1881 had been passed in 1882 and was modified in 1989 and 2002, as some more sections were added into the age old law. This act is applicable in entire India , including Jammu & Kashmir. J & K was brought in the ambit of the act in 1956. The act has provisions of Negotiable Instruments such as Promissory Notes, Checks, Drafts , Bills of exchanges etc. There are 147 different sections in this act. Initially it did not have provisions regarding the Demand Draft, which were later inserted by amendment. Key sections of this act are as follows:

  • Section 4 deals with promissory notes
  • Section 5 deals with Bill of Exchange
  • Section 6 deals with Cheque
  • Section 9 deals with holder and holder in Due course.
  • Section 15 deals with Endorsements
  • Various other sections such as 123-131 deal with crossing of cheques.

Holder versus Holder in Due Course

Holder is the person who is entitled in his own name to the possession of a negotiable instrument.

Normally a payee or endorsee is a holder.

  • Please note that holder may be or may not be with possession of the Instrument.
  • If the payee or endorsee dies, then the legal heir is the holder .
  • If there is a forged endorsement then , last endorsee is the holder.
  • If it is a bearer cheque, the person in whose name it is made is a holder.
  • If it is damaged the payee or last endorsee is the holder.
  • If it is stolen, then also payee or last endorsee is holder because a thief cannot become holder.
  • The holder has the right to obtain a duplicate of instrument is lost.
  • A holder can cross a cheque if it is not already crossed.

Holder in Due Course:

Holder in due course means a person who must have the possession of the instrument. This is the basic difference between the Holder and Holder in Due course.

  • Holder in Due course must obtain the instrument in Good Faith.
  • If the instrument bears not-negotiable crossing , then the NO person can be a holder in due course.
  • If the instrument bears A/C payee crossing and restricted endorsement then NO person can be a holder in due course.
  • Forgery / theft / deceit do not convey any title.

Promissory Note

PN means a paper with a writing which has a promise. But it does not mean that we write “I owe You” and it becomes a PN. When a person issues a promissory note, he/ she would have to stamp it as per the Indian Stamp Act and normally a revenue stamp is affixed on the PN signed by the promissory. Thus:

  • PN is always in writing.
  • PN has an unconditional undertaking called promise
  • The promise is to pay money
  • The money has to be paid to the certain person.

As per section 4 of the Negotiable Instruments Act, 1881, an instrument 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 instrument is called Promissory note.

Different types of Promissory Notes

There are two types of the promissory notes viz. Demand Promissory Note or Usance Promissory Note. Demand Promissory Note has to be paid immediately on demand and Usance Promissory Note has to be paid after certain time period.

Parties are there to a Promissory note

There are two parties in the PN. The maker is who promises to pay and the payee is who is promised to pay.

Is Currency Note a promissory note?

Although currency Notes bear the following:

I promise to pay the bearer a sum of ________Rupee/ Rupees.

However , Currency notes are money and they don’t fulfill the conditions of the Promissory note. The currency is excluded from NI act and governed by Indian Currency Act. So Currency notes are Not promissory Notes.

Bill of Exchange

BEO is a written negotiable Instrument which contains an unconditional order which is signed by the Maker; directs a certain person to pay; certain sum of Money only to, certain person or the bearer. Thus, while Promissory note has two parties, Bill of Exchange has three parties viz. Drawer, Drawee and Payee. Here drawer is the person who orders to pay; drawee is the person who is directed to pay; and payee is the person who is authorized to obtain a payment.

Under the NI Act, a minor (person of age less than 18 years) can be a Drawer but not a Drawee because he can not incur liability. Once the Drawee accepts the BOE, he becomes acceptor.

What is an Inland Bill of exchange? How it is different from Foreign Bill of Exchange?

A bill that is drawn in India and paid in India or out of India to a person, who is in India, whether Indian or Foreigner, is Inland Bill. Simply, a bill drawn in India and paid in India is a Inland Bill. A bill which is NOT drawn in India but is payable in India to a person, who is in India and is Indian or a foreigner is a Foreign Bill.

What is a Hundi?

Hundi is the Desi version of a bill of Exchange. They are used conventionally, not stamped and a vernacular language is written on them. They are still in use and are governed by local practices only.

  • Darshani Hundi is akin to a Demand Promissory Note
  • Miadi Hundi is akin to a Usance Promissory Note
  • Khoka is also a Hundi which refers to a bill of exchange that has been paid and canceled.

BOE , as per the NI act are charged at the rate of 18% per annum interest.


A cheque is a bill of exchange in which one party (Drawee) is a Bank. So a Drawer (account Holder) draws the Cheque on the (Drawee bank) in the name of a Payee.

What if different amounts in words and figures are written on a cheque?

The Drawer has to write the amount in both in figures and words. If different values are written in Figures and words, the value of words can be paid as per section 18 NI act. If the amount is written in words only and NOT in figure than NO payment will be made because it would be Inchoate (incomplete).

Bearer cheque

Bearer cheque is payable to the bearer. Sometimes “Self” is written, that is also a bearer cheque payable to the account holder.

Antedated Cheque and a post dated cheque

If a check does not bear a date, it will be returned. The holder / bearer can fill a date , if there is no date written. If the date filled is a holiday, it can be paid only after that Holiday. If a person opens an account on November 10, 2010 and gives a check to somebody with date say October 25, 2010, then it is Valid and will be paid. This is called “Ante dated Cheque”. A post dated check can bear any date of future and the payment can be stopped.

Validity of a cheque

Normal validity is 3 months but can be restricted by the account holder. The check older than 3 months is called Stale Cheque and is NOT paid and will be returned. After the state Cheque is returned , it can be revalidated for any number of times and each time it becomes valid for next 3 months.

Crossing of Cheque

Crossing provides an additional security. Crossing means that sum of that cheque can only recovered from a specified banker and it will be credited to the holders account. The crossed cheques are not paid at the counter. Crossing is applicable in case of cheques only and not in case of Bill of Exchange or promissory notes.

  • Crossing may be General crossing or Special crossing. General crossing (NI Act Section 123) is where a cheque bears two parallel lines with words such as a/c payee etc.
  • In Special crossing (NI Act Section 124) the cheque bears the name of the banker also. Section 126 directs that such cheques shall be paid to the banker to whom it is crossed specially or to his agent for collection.


The section 15 of the Negotiable Instruments Act 1881 defines endorsing as “signing on the face or an instrument for the purpose of negotiating a negotiable instrument (such as Cheque).”

Endorsing is signing in the instrument either on face or on back, for the purpose of negotiation of a NI. The person who signs is called endorser. The person in whose favor the instrument has been transferred is called Endorsee.

  • The holder of the instrument endorses the instrument.
  • If he signs only and does not mention anything else it is called Blank Endorsement.
  • If he endorses and adds a direction to pay the amount to a specified person it is called Endorsement in full.
  • If he signs and adds direction for restriction on further negotiability, then it is called Restrictive Endorsement.
  • Partial endorsement is NOT valid. This means that if Suresh issues you a check of Rs. 10000 and endorses on the backside of the check that “Pay Ramesh Rs. 5000″ it is NOT a Valid endorsement. Again if Suresh issues you a check of Rs. 10000 and endorses with a direction that ” Pay Ramesh when he passes his examination”, this is again NOT a valid endorsement. Both these conditions are called partial endorsements.
  • A minor is NOT a valid endorser.

Difference between a Crossed cheque and A/C Payee cheque

A person who signs the cheque and transfers the instrument is an endorser and in whose favor it is transferred is endorsee. The endorsee acquires a right to negotiate the instrument to anyone he / she likes. By making an endorsement the endorser promises that in case of dishonor, he / she provides a guarantee to compensate the holder.

Crossing a cheque by making two parallel lines with or without such words as ___& company is general crossing. Section 126 of the NI Act says that this is a direction to the bank to not to pay the cheque across the counter.

This crossed cheque is no more a bearer cheque where anyone can negotiate and get payment across the counter.

In case of a crossed cheque, the payee is free to make further endorsements.

For example , Ayesha receives a check from Rohan which has been crossed, Ayesha can get this payment in her account only and not across the counter. But in this case Ayesha is free to endorse the cheque in favor of Suresh and further Suresh is free to endorse the instrument in favor of Mukesh and so on…This means that crossing a cheque does not put restrictions on endorsements. In case the cheque gets dishonored, Mukesh can sue Suresh and Suresh can sue Ayesha and Ayesha can sue Rohan.

Now let’s discuss A/C Payee cheques. The NI act does not talk about the A/C payee crossing. There is no definition of A/C payee crossing in the NI act and it is a child of banking practice. Making a cheque A/C Payee is a result of custom, use and practice and is now accepted legally.

But, the A/C payee cheque cannot be further endorsed. This means that if the cheque in the above example which is in favor of Ayesha bears “A/C Payee”, payment can be collected in Ayesha’s account only. The paying bank makes sure that amount is being credited to the account of the payee only

Cheque Truncation

The NI act was amended in 2002 and after that Cheque also means a Cheque in electronic form. The clearing of checks on the basis of electronic checks is called Cheque Truncation. The Electronic image is generated and it is used for clearing, thus at that point the Physical Movement of the Cheque is stopped.

So simply, Cheque Truncation is a system of cheque clearing and settlement between banks based on electronic data/ images or both without physical exchange of instrument.

This results in faster clearance, (T+0) in local and T+1 in intercity clearing. Faster realization is accompanied by a reduction in costs for the customers and the banks. Banks can also offer innovative products and services based on CTS and there is an additional advantage of reduced reconciliation and clearing fraud.

In cheque truncation, at some point in the flow of the cheque, the physical cheque is replaced with an electronic image of the cheque and that image moves further. The processing is done on the basis of this truncated cheque and physical cheque is stored. MICR data is very useful in check truncation. The electronic cheques are issued in electronic form with digital signatures / biometric signatures / encrypted data. The negotiable Instruments (Amendment) Act of 2002 gives constitutional validity to the electronic cheques.


From January 1, 2013, cheques which do not conform to CTS-2010 standards are not entertained by banks. CTS-2010 is a set of benchmarks towards achieving standardization of cheques issued by banks all over India. These include provision of mandatory minimum security features on cheque forms such as quality of paper, watermark, bank’s logo in invisible ink, void pantograph and standardization of field placements on cheques.

This standard has been adopted due to growing use of multi-city and payable-at-par cheques for handling of cheques at any branches of a bank.

Benefits of adopting CTS-2010

  • The security features in cheque forms will assist  the presenting banks to identify the genuineness of the drawee banks’ instruments while handling them in the image-based scenario.
  • The homogeneity in security features will act as deterrent against frauds.
  • The fixed field placement specifications will facilitate straight-through-processing at drawee banks’ end through the use of optical/image character recognition technology.

The benefits from CTS are as follows:

  • Shorter clearing cycle
  • Superior verification and reconciliation process
  • No geographical restrictions as to jurisdiction
  • Operational efficiency for banks and customers alike
  • Reduction in operational risk and risks associated with paper clearing

The images of the cheques are taken using the scanners. To ascertain the uniqueness of a physical cheque and cheque image; there is a rigorous quality check process at the level of the Capture Systems and the Clearing House Interface (of the presenting bank). The CTS-2010 prescribes certain mandatory and optional security features to be available on cheques, which will also add to the uniqueness of the images.

Security of images in Cheque Truncation

The image and data transmitted over the network is secured via a comprehensive Public Key Infrastructure (PKI).

Demand Draft

Demand draft is discussed in section 85(A) of the NI Act. A Demand draft is an order to pay money drawn at one office of a Bank upon another office of the same bank for a sum of money payable to order on demand.

  • A Demand Draft is payable on demand
  • A Demand Draft can NOT be paid t a bearer
  • A DD is negotiable and its features are similar to Bill of Exchange and NOT a Check.
  • If a Bank fails to honor the Draft, the Bank is liable and not the person.
  • If there are wrong signatures on the Bank Draft, the Bank is liable.
  • If there is a prior arrangement , the DD can be payable by different bank also.

When a Bank draft is purchased , the relations between the purchaser and bank are that of a debtor and creditor , and as soon as this bank reaches the Payee, the Payee becomes beneficiary and the Bank becomes trustee.

Please note that once, the payee gets a DD, the payment CANNOT be stopped unless there is an order by a competent court. So, when a draft reaches a payee, the relationship between the purchaser and Bank comes to an end.

  • A demand draft can be prepared with cash payment if the value is less than 50,000.
  • For a value of 50,000 or more, only paid through bank account.

Draft is valid for 3 months. On expiry of this date, the draft can be revalidated by the Bank.

Difference between a Cheque and Draft

Cheque has been defined in Negotiable Instruments Act 1881 section 6. A cheque is a bill of exchange drawn on a specified bank and not expressed to be payable otherwise than on demand.

A demand draft has been defined by Negotiable Instruments Act 1881 in section 85. A demand draft is an order to pay money drawn by one office of a bank upon another office of the same bank bank for a sum of money payable to order on demand.

Following are some more differences:

  • A cheque can be made payable to bearer but a Demand Draft cannot.
  • A demand draft can be cleared in a specified branch of the issuer bank
  • A cheque can get dishonored but Demand draft is always honored.
  • An issuer party of the cheque is liable to the cheque and not backed by a Bank Guarantee, A demand draft is backed by a bank guarantee.
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