THEORIES OF COMMERCE TUTOR : ISSAR ARMAN

LESSON: THREE

TOPIC: NEGOTIABLE INSTRUMENTS

PROMISSORY NOTES
These are instruments of finance 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
the instrument.

Features of a Promissory note

 It must be in writing
 It must contain an unconditional promise to pay.
 The sum payable must be certain
 It must be signed by the maker
 It must be payable to a certain person
 It should be properly stamped.

N/B;A promissory note does not require any acceptance because the maker of the promissory
note himself/herself promises to make the payment.

Parties to a promissory note;

Maker or Drawer is the person who makes or draws the promissory note to pay a certain amount
as specified in the promissory note. He is also called the promisor.
Drawee or Payee is the person in whose favor the promissory note is drawn. He is called the
promise

Distinction between a Bill of Exchange & Promissory Note

Basis Bill of Exchange Promissory Note
Drawer Its drawn by the creditor It is drawn by the debtor
Order of Promise It contains an order to make payment. There can It contains a promise to make
& Parties be three parties to it;-the drawer,drawee & payment. There are only two
Payee parties to it the drawer and the
payee.
Acceptance It requires acceptance by the drawee or It does not require any
someone else on his behalf. acceptance.
Payee Drawer and Payee can be the same party Drawer cannot be the payee of it.
Notice In case of its dishonor Due notice of dishonor is No notice needs to be given in
to be given by the holder to the drawer. case of its dishonor.
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CHEQUES
These are negotiable instruments that are used to transfer money either in physical form or to effect
inter account transfer. They are also signed unconditional orders addressing the bank to credit it
by the issuer.

Essential Characteristics of a Cheque

 It must be in writing; a cheque must be in writing. An oral order to pay does not constitute
a cheque.
 It should be drawn on banker; It is always drawn on a specified banker. A cheque can be
drawn on a bank where the drawer has an account, saving bank or current account.
 It should contain an unconditional Order to pay; A cheque cannot be drawn so as to be
payable conditionally. The drawer’s order to the drawee bank must be unconditional and
should not make the cheque payable dependent on a contingency. A conditional cheque
shall be invalid.
 The check must have an order to pay a certain sum; The cheque should contain an order to
pay a certain sum of money only. If a cheque is drawn to do something in addition to, or
other than to pay money, it cannot be a cheque
 It should be signed by the drawer and should be dated; A cheque does not carry any validity
unless signed by the original drawer. It should be dated as well.
 It is payable on demand; A cheque is always payable on demand.
 Validity; A cheque is normally valid for six months from the date it bears, thereafter its
termed as stale cheque. A post-dated or antedated cheque will not be invalid. In both cases,
the validity of the cheque is presumed to commence from the date mentioned on it.
 It may be payable to the drawer himself; Cheques may be payable to the drawer
himself/Herself. It may be drawn payable to bearer on demand unlike a bill or pro-note.
 Banker is liable only to the drawer. The banker on whom the cheque is drawn shall be
liable only to th drawer. A holder or bearer has no remedy against the banker if a cheque
is dishonored.
 It does not require acceptance and stamp; unlike a bill of exchange, a cheque does not
require acceptance on part of the drawee. There is however, a custom among banks to mark
cheques as “good” for the purpose of clearance. Marking is not an acceptance. Similarly,
no revenue stamp is required to be affixed on cheques.
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Types of Cheques Based on methods of issuing

 Open cheque or bearer Cheque; The issuer of the cheque would just fill the name of the
person to whom the cheque is issued, writes the amount and attaches his signature and
nothing else. The cheque is negotiable from the date of issue to three months. The issued
cheque turns stale after the completion of three months. It has to be revalidated before
presenting to the bank.

 Crossed Cheque or An account Payee cheque; It is written in same as the bearer cheque
but issuer specifically specifies it as account payee on the left hand top corner or simply
crosses it twice with two parallel lines on the right hand top corner. The bearer of the
cheque presenting it to the bank should have an account in the branch to which the written
sum is deposited. It is safest type of cheques.

 A self Cheque; A self cheque is written by the account holder as pay self to receive the
money in the physical form from the branch where he holds his account.

 Pay yourself Cheque; The account holder issues this type of crossed cheque to the bank
asking the bank to deduct money from his account into bank’s own account for the purpose
of buying banking products like drafts, pay orders, fixed deposit receipts or for depositing
money into other accounts held by him like recurring deposits and loan accounts.

 Post Dated Cheque (PDC): A PDC is a form of a crossed or account payee bearer cheque
but postdated to meet the said financial obligation at a future date.

Types of Cheques Based on Functionality

 Local Cheque; A local cheque is a type of cheque which is valid in the given city and a
given branch in which the issuer has an account and to which it is connected. The producer
of the cheque in whose name it is issued can directly go to the designated bank and receive
the money in the physical form. If a given city’s local cheque is presented elsewhere shall
attract some fixed banking charges.

 At Par Cheque; With the computerization and networking of bank branches with its
headquarters, a variation to the local cheque has become common place in the name of at
par at all its branches across the county. Unlike local cheque it can be presented across the
country without attracting additional banking charges.

 Bankers Cheque; It is a kind of cheque issued by the bank itself connected to its own
funds. It is a kind of assurance given by the issuer to the client to alley your fears. The
THEORIES OF COMMERCE TUTOR : ISSAR ARMAN

personal account connected cheques may bounce for lack of funds in his account. To avoid
such hurdles, sometimes, the receiver seeks banker’s cheque.

 Traveler’s Cheques; They are a kind of an open type bearer cheque issued by the bank
which can be used by the user for withdrawal of money while touring. It is equivalent to
carrying cash but in a safe form without fear of losing it.

Circumstances when a banker refuses payment of Cheque;

When the Customer has countermanded Payment

If a customer countermands Payment i.e., issues instructions to his/her banker not to pay or
honour,i.e ‘stop payment’ of a particular cheque issued by him/her, the banker is bound to comply
with such instruction. It is important to note that the customer must duly sign the countermand
notice, which should contain correct particulars of the cheques and give to the banker in sufficient
time, ie before the banker makes the payment of the cheque that is desired for ‘stop payment’.
However, it is not necessary that such a notice be given in writing always. An oral countermand is
equally effective,

When the banker has received a Garnishee order

Garnishee order implies a prohibiting order by a court of law attaching the funds in the customers’
account. On receipt of such order, the banker must refuse the payment of the customer’s cheque.
If the banker by mistake makes payment of any cheque after receipt of such order, it will have to
bear the loss itself. In this case it cannot recover from the payee who gets payment of an otherwise
valid cheque.

When the Customer has died

If the banker receives notice of a customer’s death, it must dishonor the cheque presented to it after
the notice of death. However, a banker is justified in making payment if such payment is made
before receiving the notice of death and the payment so made is valid.

When the account is closed

When the customer gives notice to the banker for closing his account, the banker must not pay the
customers’ cheques after that date i.e the date of closing of the account.

Where the instrument has been materially altered

When there is a material alteration on the instrument or where the signature of the drawer does not
match with the specimen signature kept by the banker, the latter must dishonor such cheques.
However, in case of payment by mistake, the banker is entitled to a refund from the wrong payee
if traceable, failing which the banker will have to bear the loss itself.
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When the customer has lost the instrument

When the customer has lost the cheque and has informed the banker about the loss of the
instrument, the bank must in turn, dishonor the cheque.

When the customer has become insolvent or insane

A banker must also refuse payment of cheques when its customer has been adjudged insolvent or
has become insane since in such cases its original authority to pay on behalf of the customer ceases
to exist. A fresh authority is required on those accounts. If a banker makes any payment even after
receiving a due notice as regards insolvency or insanity of the account holder, such payment is not
good against the drawer and in such a case the banker cannot get a refund from the payee, who
gets payment of an otherwise valid cheque.

Where the banker has received a Notice of Assignment

When the banker receives notice of assignment from the customer about his credit balance, it must
refuse payment of the cheque(s) drawn by that customer.