What are Negotiable Instruments?


Negotiable instruments in India are governed under the Negotiable Instruments Act, 1881. Under this act, the instruments are defined and their usage is governed. With reference to Section 13(A) of the Act, a negotiable instrument means ‘a promissory note, bill of exchange or cheque payable either to order or to bearer, whether the word “order” or “bearer” appears on the instrument or not.’  To explain things further, a negotiable instrument is a document that guarantees the payment of a specified sum of money either on demand or after a stipulated period of time.




There are many Negotiable Instruments. However, the Act takes into consideration only three.


The Act does not include demand drafts and hundis which are also popular negotiable instruments. Negotiable instruments can be categorized into two main types:


Order to pay– Drafts and cheques


Promise to pay– bills of exchange and promissory notes.


Negotiable Instruments Criteria


The instrument must be in written form;


Promise or order to pay must be unconditional;


The payment must be of a specified sum of money to which interest may be added;


The payment must either be made after a set time or on demand;


The instrument must be payable to bearer or to order;


The instrument must not require the person promising payment to perform any other action other than payment.


Types of Negotiable Instruments


Bill of Exchange


An instrument containing an unconditional order and signed by the maker, directing a certain party to pay a certain sum of money to the bearer of the instrument. They are issued by banks, thus making this a three-party affair.


The payee is the party receiving the payment (the creditor)


Drawee is the party making the payment (the debtor)


Drawer obliges the drawee to pay the payee (bank)


Banks can choose to perform the function of discounting the bill of exchange. Banks provide short term credit to the holder of the bill based on these bills of exchange. This discount rate includes the interest rate and other nominal charges. The interest rate increases in proportion to the maturity period of the bill. The earnings of the bank are termed as proceeds which is the difference between the face value and the discount value. At maturity, the bank receives the original face value as reimbursement and the payee receives the discounted value.


Promissory Note



Promissory notes are legal instruments in which one party promises to pay in writing a specific sum of money to the other party, either after a stipulated time period or on demand under specific terms.


Promissory notes are sometimes signed as part of a student loan process.


The bank holds on to that promissory note until the loan is paid back in full.


Promissory notes transform into financial instrumentswhen the creditors have enough payments pending to be made, leading them to a situation where their own liquidity is questionable, approach banks for short term credit where they encash the promissory note at a discounted value and make their due payments.


At the time of maturity, the issuer of the promissory note pays the bank directly in full. The difference is the profit of the bank for rendering their services.


Cheque


Cheques are negotiable instruments used to make payments as part of the day to day business transactions. It is the most popular one and used by businesses and individuals to make and receive payments on a daily basis. Three parties are involved in a cheque transaction.


Drawer– The party issuing the cheque and holding an account with the bank;


Drawee– The party which is directed to make the payment ie. bank;


Payee– The party which receives the payment made by the drawee. If the drawer has drawn the cheque in favor of self then the drawer becomes the payee.


The cheque acts as a written order made by the drawer to the drawee to pay the payee the amount of money specified on the cheque. The drawer’s account will be debited by the amount mentioned on the cheque. The bank earns the nominal feecharged to the customers for granting them checkbooks. Different types of cheques issued are Bearer Cheque, Order Cheque, Crossed Cheque, Stale Cheque, Anti Dated Cheque and Post Dated Cheque.


Features of Negotiable Instruments


A negotiable instrument can be transferred in a hassle-free manner through delivery or endorsement. Formalities such as preparing a transfer deed, payment of stamp duty, etc are absent. Transfer does not even mandate notifying the previous holder of the instrument.


The instrument is in written form. It can be handwritten, typed, engraved or printed.


The time period after which payment is made is certain and unambiguous. Also, the holder anticipates prompt payment because dishonor would imply the ruin of credit of all parties involved. Every instrument contains an unconditional promise or order of payment.


The payee is specified in the instrument. There may be situations where there is more than one payee. The payee can be an institution or organization too.


For a negotiable instrument to be considered valid, the signature of the maker or the drawer needs to be present on the document.


A person or party receiving the negotiable instrument has indisputable ownership.


A negotiable instrument is not complete until and unless it has been delivered to the payee.


Negotiable Instruments Utility


Negotiable instruments are of utmost importance in the commercial world. It has consistently increased in tandem with development in international trade.


The right of property which implies complete ownership accompanies the promissory right.


The transferability from one person to another happens with ease and without much formality which facilitates its heavy use in the business world.


The transfer can be done through endorsement or delivery, which is a common occurrence in business transactions.


Payments made through instruments are immediate, thus minimizing loss of time.


Even after an electronic revolution in the banking sphere, negotiable instruments are still used widely. They may face obsolescence once people develop their banking habits and overcome the problems faced due to the digitization of banks.