Negotiable Instruments Act, 1881: Simplified Guide

Stuti Mishra

5 months ago

The Negotiable Instruments Act, 1881 defines a negotiable instrument as a unique type of “contract” involving the payment of money. It ensures that the payment is made either to a specific person or to the bearer of the instrument on a specified date. Common examples of negotiable instruments include cheques, promissory notes, bills of exchange, and treasury bills. Understanding these concepts is crucial for UGC NET Commerce aspirants. This article will cover all the nooks and corners of the Negotiable instrument.

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Features of Negotiable Instruments Act, 1881

It governs negotiable instruments like cheque, promissory notes, and bills of exchange.
It defines the characteristics and transferability of negotiable instruments.
It ensures a legal promise of payment to the holder or assignee.
It provides a framework for endorsement and transfer of negotiable instruments.
It specifies liability of parties involved (drawer, drawee, payee).
This act addresses the time frame for presenting negotiable instruments for payment.
Ensures that a valid instrument is legally binding, even if conditions are not fulfilled.

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What is Negotiable Instrument?

Negotiable instruments are documents that guarantee payment to the assignee or a specified person.
These are signed, transferable documents promising to pay a fixed sum of money.
Payment is made either on demand or at a specified future date.
The holder of the instrument has the legal right to use the funds as needed.
Upon transfer, the new holder obtains full legal ownership of the instrument.

Classification of Negotiable Instruments

1. Inland Instrument:

It is a bill of exchange drawn and payable within India, or drawn upon a person residing in India.

2. Foreign Instrument

It is an instrument not considered an inland bill, typically drawn outside India.
Foreign instruments require protest for dishonor, unlike inland bills.

3. Instruments Payable on Demand

Cheques are payable on demand and cannot specify otherwise.
A negotiable instrument is payable on demand if no payment time is stated or if it includes terms like “on demand” or “at sight.”

4. Ambiguous Instrument

A draft that can be interpreted either as a promissory note or a bill of exchange.
The holder must decide its classification.

5. Forged Instrument:

An instrument altered or forged with the intent to deceive, such as using a fictitious signature or forging someone else’s name.

6. Bearer and Order Instruments

It is an instruments payable to the bearer or order, where the holder in possession is entitled to enforce payment.

Parties Involved in Negotiable Instruments:

Drawer: The person who creates and signs the negotiable instrument (e.g., a cheque or promissory note), directing payment.
Drawee: The person or entity (usually a bank) who is ordered to make the payment as per the negotiable instrument.
Payee: The person to whom the payment is made or who is entitled to receive the amount specified in the instrument.

Types of Negotiable Instrument

Various types of negotiable instrument are as follows:

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1. Promissory Note

A written promise to pay a specific sum of money to a person or bearer at a specified time.
Must be signed by the maker and contains no conditions.

2. Cheque

It is a written order directing a bank to pay a specific amount from the drawer’s account to the payee.
Commonly used for everyday transactions.

3. Bill of Exchange

It is a written order by one party (drawer) directing another party (drawee) to pay a specified sum to a third party (payee) on demand or at a future date.
Often used in international trade.

4. Bank Draft

A payment instrument issued by a bank on behalf of a customer, payable to the payee.
More secure than a personal cheque as the bank guarantees payment.

5. Treasury Bill

A short-term government security issued to meet short-term funding requirements.
Generally, a highly secure investment.

6. Bearer Instrument

An instrument payable to whoever holds it, not requiring endorsement.
Transferable by mere delivery.

7. Order Instrument

Payable only to the person named or their endorsed party.
Requires endorsement for transfer.

Penalties under Negotiable Instrument Act 1881

Under the Negotiable Instruments Act, 1881, there are several penalties and punishments for dishonor of negotiable instruments, particularly cheques. The law outlines the following key punishments and penalties:

1. Dishonor of Cheques (Section 138)

Penalty for dishonor: If a cheque is dishonored due to insufficient funds or if the drawer has no account, the drawer can face:
- Imprisonment for up to 2 years or
- A fine that may extend to twice the amount of the cheque or both.
Purpose: This provision aims to discourage the issuance of dishonored cheques and to ensure the integrity of financial transactions.

2. Penalty for Failure to Pay (Section 139)

The drawer of a dishonored cheque has a specific period (usually 30 days from receipt of notice) to make the payment.
Failure to pay within this time frame leads to prosecution.
If the drawer does not make the payment after the notice period, they can be held liable for the dishonor under Section 138.

3. Punishment for Other Offenses (Section 142)

The law also prescribes punishments for other offenses under the Act, such as knowingly issuing a fraudulent or forged negotiable instrument.
Punishment can range from imprisonment to fines, depending on the nature and seriousness of the offense.

4. Interim Compensation (Section 143A)

Under the Negotiable Instruments (Amendment) Act, 2018, Section 143A allows the court to order interim compensation to the complainant during the pendency of a case of dishonored cheques.
This compensation is typically up to 20% of the cheque amount and is intended to provide some financial relief to the payee during the trial process.

5. Appeal and Further Penalties (Section 148)

Under Section 148, the appellate court may order the drawer of a dishonored cheque to deposit 20% of the fine or compensation during the appeal process.
This is designed to prevent delay tactics in dishonored cheque cases.

Negotiable Instruments Act 1881 – Conclusion

The Negotiable Instruments Act, 1881 plays a pivotal role in regulating financial instruments such as cheques, bills of exchange, and promissory notes in India. It defines key terms and the rights and obligations of the parties involved. Through provisions like Section 138 (dishonor of cheques), the Act establishes penalties, including fines and imprisonment, to ensure the integrity of financial transactions. Amendments like Section 143A (interim compensation) and Section 148 (appeal penalties) reflect a focus on expediting justice and protecting both payees and drawers. These provisions continue to foster trust and security in commercial transactions, making the Act an essential pillar of Indian commercial law.

UGC NET MCQ based on Negotiable Instruments Act, 1881

Q1. Which section of the Negotiable Instruments Act, 1881 deals with the dishonor of cheques due to insufficient funds?
a) Section 139
b) Section 138
c) Section 143
d) Section 142

Answer: b) Section 138

Q2. Which of the following is NOT considered a negotiable instrument under the Negotiable Instruments Act, 1881?
a) Cheque
b) Promissory Note
c) Letter of Credit
d) Bill of Exchange

Answer: c) Letter of Credit

Q3. What is the maximum imprisonment term for dishonoring a cheque under Section 138 of the Negotiable Instruments Act, 1881?
a) 1 year
b) 2 years
c) 3 years
d) 5 years

Answer: b) 2 years

Q4. Under the Negotiable Instruments (Amendment) Act, 2018, what relief does Section 143A provide to the complainant in a cheque dishonor case?
a) Full payment of the dishonored cheque amount immediately
b) Interim compensation up to 20% of the cheque amount
c) Refund of legal expenses
d) Compensation for lost income due to the dishonor

Answer: b) Interim compensation up to 20% of the cheque amount