Negotiable Instruments Act

Last Updated On -24 Jan 2025

Act No. 26 of 1881, or the Negotiable Instruments Act 1881, exists to define and amend the law relating to Promissory Notes, Bills of Exchange, and Cheques.

The act was originally drafted in 1866 but was re-drafted for the fourth and final time by the law commission, in 1881.

According to Section 1, it extends to the whole of India.

Passed around the British Colonial Rule, it is still in force with significant changes made recently. The Act comprises 148 sections, divided into 17 chapters.

The act was mainly established to eliminate dishonor or misuse of financial instruments.

The Negotiable Act, was enacted, formalizing the usage and characteristics of instruments like the cheque, the bill of exchange, and promissory notes. The NI Act provided a legal framework for non-cash payment instruments in India.

What is a Negotiable Instrument?

According to Section 13 of the Negotiable Act, “ A “negotiable instrument” means a promissory note, bill of exchange or cheque is payable to order which is expressed to be so payable or which is expressed to be payable to a particular person and does not contain words prohibiting transfer or indicating an intention that it shall not be transferable”.

In simpler terms, it is a piece of paper considered a document, guaranteeing the payment of a specific amount of money, either on demand or at a set time, whose payer is usually named on the document.

The word “negotiation” refers to transferability, and “instrument” refers to a document giving legal effect.

Since the NI Act refers to the usage of financial instruments, the Hundi has been traditionally used in India, and Section 1 mentions the saving of usage of the Hundi, let us talk about it.

Hundi

A hundi is a traditional financial instrument, similar to a bill of exchange or promissory note, equivalent in reference to the present time as a traveler's cheque. So, what does the NI Act, Section 1 mean by “saving of usage relating to hundi”?

At the time of issue of a hundi, it can be transferred multiple times before being presented as payment. Thus, to avoid multiple transfers and misuse, the holder may transfer the hundi with the words “saving of usage”, meaning further transfers are prohibited.

This eliminates the over-circulation and potential fraud of hundi.

Types of Negotiable Instruments

The Negotiable Act, of 1881, consists of three primary types of Negotiable or financial instruments in Sections 4, 5, and 6.

The three primary types of negotiable instruments:

Promissory Note

A “Promissory note” is an instrument in writing (not being a bank note or a currency note), in which one party (the issuer) promises to pay a fixed sum of money to the other (the payee), either at a fixed future time or on demand of the payee, under specific terms and conditions.

It differs from an “IOU” by stating the pay promise with the steps and definite time of payment as well as bears consequences if not paid. Whereas, an IOU only specifies that a debt exists.

A promissory note cannot be used as private money.

Bill of Exchange

A “Bill of Exchange” or “draft” 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.

They are used mostly in international trade and are not used as often today.

It was essentially issued by one person ( the drawer)to another person ( the drawee) to pay a third person (the payee).

Cheque

A “cheque” is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand and it includes the electronic image of a cheque in the electronic form.

The person writing the cheque, known as a drawer, has a transaction banking account, often referred to as a current, cheque, or share draft account.

Contents of the Negotiable Act of 1881

According to the 148 sections mentioned in the NI Act, there are a few important content regulations that enable people to understand the guidelines to follow.

A few of the highlighted points from the NI Act are:

According to the law, every person capable of contracting is capable of transferring or negotiating a promissory note, bill of exchange, or cheque.
A negotiable instrument made, drawn, accepted, endorsed, or transferred without consideration, or for a consideration which fails, creates no obligation of payment between the parties.
When a negotiable instrument has been lost or has been obtained from any maker, acceptor, or holder, has the authority to receive the amount from the holder.
The making, acceptance, or endorsement of a promissory note, bill of exchange, or cheque is completed by delivery.

Reforms in the Negotiable Act

The Negotiable Instrument Act which was implemented in 1881, was amended in the year 1988 to include cheque fraud. Under this act, the people issuing cheques without having sufficient money in their accounts are considered fraud and are charged a penalty, considering it as a criminal offense.

Parliament enacted the Negotiable Instruments Act, of 2002, which was made to plug the loopholes, including cheque truncation or clearance through digital mode, and this act came into force on 6 February 2003.

Frequently Asked Questions (FAQs)

What are the important features of the Negotiable Instrument Act?

The important features of the Negotiable Instrument Act are:

It promises an unconditional sum of money.
It is payable either on demand or after a specified period.
Freely transferable by delivery.

What are the penalties for dishonoring a cheque under the act?

Under section 138, if a cheque is dishonored, due to insufficient funds or other reasons, the drawer may face:

Imprisonment of 2 years
A fine up to twice the amount of the cheque, provided certain conditions are made.

What does endorsement mean?

Endorsement refers to a process where a holder of a negotiable instrument signs on the back of the document, allowing it to be transferred to another party.