A Negotiable Instrument is a signed document that promises a sum of payment to a specified person or the assignee. The key feature is that it is freely transferable from one person to another. The three main types defined under the Negotiable Instruments Act, 1881, are:
- Promissory Note
- Bill of Exchange
- Cheque
For banking operations, the cheque is the most common and important negotiable instrument.
Parties to a Cheque
- Drawer: The person who writes or “draws” the cheque and signs it. This is the person whose account will be debited.
- Drawee: The bank on which the cheque is drawn. This is the bank that is ordered to make the payment.
- Payee: The person to whom the money is to be paid.
Collection of Cheques
When a customer deposits a cheque into their account, the bank acts as a collecting banker. Its main role is to collect the money from the drawee bank on behalf of its customer.
Duties of a Collecting Banker:
- Due Diligence: The bank must act with reasonable care and diligence in the collection process.
- Presentment of Cheque: The bank must present the cheque for payment within a reasonable time.
- Serving Notice of Dishonour: If the cheque is dishonoured (bounced), the collecting bank must immediately inform its customer so they can take legal action against the drawer.
Payment of Cheques
When a cheque is presented to the bank on which it is drawn, that bank acts as the paying banker. Its role is to pay the cheque, provided certain conditions are met.
Statutory Protection for a Paying Banker:
A paying banker is protected by law if it makes a payment in “due course,” even if there is a problem later (like a forged signature of an endorser). Payment in due course means the payment must be:
- In accordance with the apparent tenor of the instrument.
- Made in good faith and without negligence.
- To a person in possession of the instrument.
When a Paying Banker MUST Refuse Payment:
- When the customer issues a “stop payment” instruction.
- Upon receiving notice of the customer’s death, insolvency, or insanity.
- If there are insufficient funds in the account.
- If the cheque is post-dated or stale (older than 3 months).
- If the customer’s signature does not match the specimen signature.
Crossing of Cheques
A crossing is an instruction to the paying banker to pay the cheque only to another banker and not directly to the person at the counter. This is done by drawing two parallel transverse lines across the face of the cheque.
- Purpose: It is a security measure that ensures the money is paid into a bank account, creating a trail for the funds and preventing wrongful payment.
- Types:
- General Crossing: Just two parallel lines.
- Special Crossing: The name of a specific bank is written between the lines.
- “Account Payee” Crossing: This is a direction to the collecting banker to credit the amount only to the account of the payee named on the cheque.
Promissory Note
A Promissory Note is a written, unconditional promise made by one person (the Maker) to pay a certain sum of money to another person (the Payee).
Simple Analogy: It’s a formal and legally binding “I Owe You” (IOU).
Parties Involved (2 Parties)
- Maker: The person who makes the promise and signs the note. This is the debtor.
- Payee: The person to whom the payment is to be made. This is the creditor.
Example
Imagine Ram buys goods worth ₹10,000 from Shyam on credit. Ram gives Shyam a signed note that says, “I promise to pay Shyam or his order the sum of ₹10,000 after three months from this date.”
- Maker: Ram (the debtor)
- Payee: Shyam (the creditor)
Bill of Exchange
A Bill of Exchange is a written, unconditional order signed by the maker (the Drawer), directing a certain person (the Drawee) to pay a certain sum of money to a certain person (the Payee).
Simple Analogy: It’s a formal “You Pay Him” order.
Parties Involved (3 Parties)
- Drawer: The person who makes the order. This is the creditor.
- Drawee: The person who is directed to pay. This is the debtor.
- Payee: The person to whom the payment is to be made. (The Drawer and the Payee can be the same person).
Acceptance: A bill of exchange is not binding on the Drawee until they “accept” it, usually by signing across it.
Example
Imagine ABC Exports (the seller) sells goods worth ₹50,000 to XYZ Imports (the buyer). ABC Exports draws a bill on XYZ Imports, ordering them to pay the money to DEF Bank after 60 days.
- Drawer: ABC Exports (the creditor)
- Drawee: XYZ Imports (the debtor)
- Payee: DEF Bank
Summary of Key Differences
| Feature | Promissory Note | Bill of Exchange | Cheque |
| Nature | A Promise to pay | An Order to pay | An Order to pay |
| Parties | Two (Maker, Payee) | Three (Drawer, Drawee, Payee) | Three (Drawer, Drawee, Payee) |
| Made by | The Debtor | The Creditor | The Debtor (Customer) |
| Drawee | Not Applicable | Can be any person/firm | Always a Bank |
| Acceptance | Not required | Must be accepted by the Drawee | Not required |
| Payable on Demand | Can be | Can be | Always is |