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Negotiable Instruments

A negotiable instrument is a document, which promises the payment of a fixed amount of money and may be transferred from person to person. The two functions that are served by negotiable instruments are a payment function and a credit function. Negotiable means transferable and hence, negotiability allows the transfer of ownership from one party to another by delivery or endorsement. Delivery is the transfer of possession actual or constructive, from one person to another. y Endorsement is the action of signing an instrument to make it payable to another person or cashable by any person. That means merely signing your name on the back of the document, or adding an instruction such as pay to the order of Person A . y A negotiable instrument is freely transferable. The ownership in case of a negotiable instrument is changed by mere delivery (when payable to the bearer) or by valid endorsement and delivery (when payable to order). Further, while transferring it is also not required to give a notice to the previous holder. y A negotiable instrument must be in writing. This includes handwriting, typing, computer print out and engraving, etc. In every negotiable instrument there must be an unconditional order or promise for payment. y The instrument must involve payment of a certain sum of money only and nothing else. The time of payment must be certain. It means that the 1

instrument must be payable at a time which is certain to arrive. If the time is mentioned as when convenient it is not a negotiable instrument. However, if the time of payment is linked to the death of a person, it is nevertheless a negotiable instrument as death is certain, though the time thereof is not. y The payee must be a certain person. It means that the person in whose favour the instrument is made must be named or described with reasonable certainty.

Types of Negotiable Instruments


The different types of negotiable instruments include Promissory notes, cheques, and bills of exchange. Letter of credit is also considered to be a negotiable instrument if it fulfils a certain criteria.

Promissory Note:
"Promissory note." A "promissory note" is in an instrument in writing (not being a bank-note or a currency note) containing an unconditional undertaking signed by the maker, to pay on demand or at a fixed or determinable future time] a certain sum of money only to, or to the order of a certain person, or to the bearer of the instrument. y The person who makes the note and promises to pay the amount stated therein is the Maker or Drawer. the person to whom the amount is payable is the Payee. y In case the payee transfers the promissory note, the person who endorses the note in favour of another person is the Endorser. The person in whose favour the note is negotiated by endorsement is the Endorsee.

A promise or order to pay is not conditional and hence, cannot be expressed to be after a certain lapse of time of after occurrence of a certain event.

A promissory note may be payable on demand or after a certain date. The sum payable mentioned must be certain or capable of being made certain. It means that the sum payable may be in figures or may be such that it can be calculated.

Loans are typically formalized in promissory notes, and since they often provide for payments over time, they function to provide credit to the borrower who is the maker of the note.

Bills of Exchange:
It is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to or to the order of a certain person, or to the bearer of the instrument. A bill of exchange is a three-party written order signed by the first party (the drawer), requiring the second party (the drawee) to make a specified payment to a third party (the payee) on demand or at a fixed future date y The person who makes the order for making payment is the Drawer. The person to whom the order to pay is made is the Drawee, who is generally a debtor of the drawer. y The person to whom the payment is to be made is called the Payee. The drawer can also draw a bill in his own name thereby he himself becomes the payee. y In a bill where a time period is mentioned is called a Time Bill. A bill may also 3

be made payable on demand. This is called a Demand Bill. y A cheque is a type of bill of exchange where the drawee is always a bank and is payable on demand. The main difference between promissory notes and bills of exchange is that the promissory notes pay interest while bills of exchange don t. y The order must be unconditional. The order must be to pay money and money alone. The sum payable mentioned must be certain or capable of being made certain. The parties to a bill must be certain.

Cheques:
A bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. Cheque is a very common form of negotiable instrument. If you have a savings bank account or current account in a bank, you can issue a cheque in your own name or in favour of others, thereby directing the bank to pay the specified amount to the person named in the cheque. y A cheque may be regarded as a bill of exchange. The only different between a cheque and a bill of exchange is that in case of a cheque, the bank is always the drawee. y It contains an unconditional order. It is issued on a specified banker only. The amount specified is always certain and must be clearly mentioned both in figures and words. The payee is always certain. It is always payable on demand. y The cheque must bear a date otherwise it is invalid and shall not be honoured by the bank. Following are the four main types of cheques: 4

a) Open cheque: A cheque is called Open when it is possible to get cash over the counter at the bank. If someone holds an open cheque, he can receive its payment over the counter at the bank, deposit the cheque in his own account and can also pass the cheque on to someone else by signing on the back of the cheque. b) Crossed cheque: Since open cheque is subject to risk of theft, it is dangerous to issue such cheques. This risk can be avoided by issuing another types of cheque called Crossed cheque . The payment of such cheque is not made over the counter at the bank. It is only credited to the bank account of the payee. A cheque can be crossed by drawing two transverse parallel lines across the cheque, with or without the writing Account payee or Not Negotiable . c) Bearer cheque: A cheque which is payable to any person who presents it for payment at the bank counter is called Bearer cheque . A bearer cheque can be transferred by mere delivery and requires no endorsement. d) Order cheque: An order cheque is one which is payable to a particular person. In such a cheque the word bearer may be cut out or cancelled and the word order may be written. The payee can transfer an order cheque to someone else by signing his or her name on the back of it.

Letter of Credit:
A commercial letter of credit is a contractual agreement between a bank, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank

makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee. y Letters of credit are usually negotiable. To be negotiable, the letter of credit must include an unconditional promise to pay, on demand or at a definite time. The nominated bank becomes a holder in due course. y The standby letter of credit serves a different function than the commercial letter of credit. The commercial letter of credit is the primary payment mechanism for a transaction. The standby letter of credit serves as a secondary payment mechanism. A bank will issue a standby letter of credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract between the beneficiary.

List of References
1. Negotiable Instruments http://www.translegal.com/lets/negotiable-instruments 2. Understanding and Using Letters of Credit http://www.crfonline.org/orc/cro/cro-9-1.html 3. The Negotiable Instruments Act, 1881. http://www.jamilandjamil.com/publications/pub_commercial_laws/act1881. htm