Mercantile and industrial laws Chapter 2 The law governing negotiable instruments

The law governing negotiable instruments e.g., Bills of Exchange, Promissory Notes and Cheques is contained in the Negotiable Instruments Act, 1881 which was adopted by Pakistan in August, 1947. DEFINITIONS A negotiable instrument has been defined in law as a promissory note, bill of exchange or Cheques payable either to order or to bearer. The peculiarity of the negotiable instrument is that its transferee gets a good title of the transferor, provided he receives the documents: 1. In good faith; 2. In proper form; 3. Before maturity, and 4. For value. In case of other documents, the transferee does not ordinarily get a better title than that of his transferor. But this is not so in the case of a negotiable instrument. CHARACTERISTICS OF A NEGOTIABLE INSTRUMENT The following are the chief characteristics of a negotiable instrument: 1. Property in it can be transferred by endorsement and delivery or by delivery alone, as the case may be. 2. A holder in due course, i.e., a person who receives it in good faith, in proper form, for value and before maturity, gets a good title to it in spite of a defect in the title of the transferor. 3. 4. The holder in due course can sue in his own name. It passes from hand to hand just like cash and performs many functions of money.

5. It is an easy and convenient means of assigning a debt. 6. The debt due under a negotiable instrument can be assigned to a third party by negotiation. The three kinds of Negotiable Instruments are: 1. Bills of Exchange, 2. Promissory Notes, and 3. Cheques.

NOTES, BILLS AND CHEQUES Promissory Note

A promissory note has been defined as an instrument in writing (not being a bank note or currency note) containing an unconditional undertaking signed by the maker, to pay certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument. According to this definition, the following are the essentials of a Promissory Note: 1. It must be in writing. 2. It should contain an unconditional promise to pay, i.e., the promise to pay must not depend upon the happening of certain event. 3. The amount promised to be paid must be a certain sum of money only and not cattle or books or any other thing. 4. It must be signed by the maker. 5. It must be payable to or to the order of, a certain person or to the bearer of the instrument. 6. Place, date and time of payment are not the essentials of a promissory Illustrations. A signs instruments on the following terms: 1. I promise to pay B on order Rs. 5,000. 2. I acknowledge myself to be indebted to B for Rs. 8,000 to be paid on demand, for value received. 3. Mr. B., I.O.U. Rs. 8,000 4. I promise to pay B Rs. 5,000 and all other sums which shall be due to him. 5. I promise to pay B Rs. 5,000 first deducting there out any money which he may own me. 6. I promise to pay B Rs. 5,000 seven days after marriage with C. 7. I promise to pay B Rs. 5,000 on D's death, provided D leaves me enough to pay that sum, 8. I promise to pay B Rs. 5,000 and to deliver to him my white horse on 1st January next Solution: The instruments respectively marked (1) and (2) are promissory notes. The instruments respectively marked (3), (4), (5), (6), (7) and (8) are not promissory notes.

Bill of exchange
A bill of exchange 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. The characteristics of a bill of exchange are: 1. It must be in writing. 2. It must be an unconditional order to pay. 3. It must be signed by the maker. 4. The maker directs a certain person to pay money. 5. The payment must be of certain sum of money only.

Cheque
A Cheque has been defined as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. A Cheque, it should be remembered, is always drawn on a bank and is always payable on demand. It is, thus an unconditional and written order drawn on a bank directing it to pay a certain sum of money to a person or his order. SPECIMEN OF CHEQUE No................................... Date_ Muslim Commercial Bank Limited, Lahore Lahore

Pay to.......................................................................................................................or Bearer Rupees Rs Signature PARTIES TO INSTRUMENTS the Maker, Payee, Drawer and Drawee In the case of a promissory note, there are only two parties: (1) The party making the note, known as the Maker; and (2) the party who is required to pay the money, called the Payee. A bill of exchange has three parties: (1) The party who draws the bill, called the Drawee; (2) the party on whom the bill is drawn called the Drawer; and (3) the party to whom the payment is to be made called the Payee. When the drawer is himself the payee, then there are only two parties to a bill of exchange. After a bill of exchange is prepared, the drawer presents it to the drawee who signs his assent upon the bill. It is known as Acceptance; and the drawee after acceptance comes to be known as Acceptor. What is true of a bill of exchange is also true of a Cheque, for the latter is just a variety of the former, except that it is not accepted. The Holder The holder of a promissory note, bill of exchange, or a Cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount due thereon from the parties thereto. Where the note, bill, or Cheque is lost or destroyed, its holder is the person so entitled at the time of such loss or destruction. Mere possession of a negotiable instrument does not make him a holder. He must, in order to be a holder, have two qualities. 1. Firstly, he must be entitled in his own name to the possession of the instrument. He may or may not possess the document, but he must be entitled to possess it in his own name. 2. Secondly, he must be entitled in his own name to recover the amount due thereon from the parties thereto. This condition is very important. Suppose A loses a bill of exchange which is found by B. Now B is not its holder, though he possesses it, because he is not entitled in his own name to receive the amount from the acceptor. Similarly, if a thief steals a Cheque, he will not be called its holder for he is not entitled in his own name to receive the Cheque from the hank. The Holder in due Course The Holder in due course means any person who became the possessor of a promissory note, bill of exchange or Cheque if payable to bearer or payee or endorse thereof if payable to order (1) for consideration, (2) before the amount mentioned in it became payable, and (3) without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title. In simple language any person who becomes a holder of a negotiable instrument (a) for value, (b) before maturity of the instrument, and (c) in good faith; is known as a holder in due course. A fourth condition is sometime added to the other three, namely, that the document must be in proper form. The instrument must be received for value if the holder is to become holder in due course. Otherwise he will remain just a holder. If I give a Cheque of Rs. 30,000 to the trustees of the Commerce College, Lahore, for the benefit of that institution, the trustees receive the Cheque without paying any value. Hence they are holders of the Cheque but not holders in due course. In case my title to the Cheque turns out to be bad, the title of the trustees to that Cheque will also be bad; for the title of the holder of a negotiable instrument cannot be better than that of the transferor. Again, the holder must act honestly and must receive the instrument in good faith. He must know that the title of the transfer is good.

Finally, the holder in due course must receive the instrument with due exercise of intelligences and caution, and must see that the instrument is complete and in proper order. When a negotiable instrument has been lost, or has been obtained from any maker, acceptor, or holder thereof by means of an offence or fraud or for an unlawful consideration, no possessor or endorsee who claims through the person who found or so obtained the instrument is entitled to receive the amount due thereon from such maker, acceptor or holder, or from any party prior to such holder, unless such possessor or endorsee is, or some person through whom he claims was, a holder thereof in due course. The man who finds a lost instrument or who steals an instrument acquires no title to it; and the real owner of the instrument can take it back from him. But if the instrument is a bearer instrument or bears a blank endorsement and the finder or thief transfers it to an innocent person for value and before maturity, the transferee gets a good title to it in spite of a defect in the title of the transferor. But if the instrument happens to be payable to order and the finder or the thief who finds it without endorsement transfers it to an innocent holder without endorsement or with a forged endorsement, the transferee does not acquire a good title. Forgery gives no title. The Holder for Value The holder for value should be distinguished from holder in due course. A holder for value is the holder of an instrument for which value has been paid at some time though not necessarily by him. For instance, you may donate a Cheque of Rs. 8,000 received from your debtor to a mosque. In this case, value has been paid for the Cheque by you and not by the trustees of the mosque who are holders for value. As against this, a holder in due course always pays value for the instrument himself. Again, the title of a holder for value cannot be better than that of its transferee; but a holder in due course acquires a good title to the instrument. NEGOTIATION According to law, when a promissory note, bill of exchange or Cheque is transferred to any person, so as to constitute that person the holder thereof, the instrument is said to be negotiated. In other words, an instrument is said to have been negotiated only if the transferee becomes entitled in his own name to its possession and to recover the amount due there under. The transfer of the instrument must be made in such a manner as to transfer the property in it to the transferee. If the transfer of instrument does not convey properly with it, it will not amount to negotiation. For instance, if you deposit a Cheque for Rs. 5,000 with the Imperial Bank for safe custody, the Cheque is not negotiated, but simply transferred. Negotiability thus differs from transferability. A bearer instrument can be negotiated by mere delivery. But an order instrument must be endorsed as well as negotiated in order to constitute negotiation. ENDORSEMENT A negotiable instrument may be payable either to the order of the person named therein or to the bearer of the instrument. A bearer instrument can be negotiated simply by delivery. For instance, if you have a bearer Cheque, made payable to Mr. X or bearer, you can hand it over to your creditor and that would be quite a valid negotiation. But an order instrument is negotiated by endorsement as well as delivery. If the Cheque in the above case were payable to Mr. X order, Mr. X must first endorse it and then hand it over to his creditor in order to constitute a valid negotiation. When the maker or holder of a negotiable instrument signs the same otherwise than as such maker, for the purpose of negotiation, he is said to endorse the same. The person who makes an endorsement is known as endorser; while the person in whose favor it is endorsed is called endorsee. The Place of Endorsement As a general rule, the endorsement is placed on the back of the instrument. But it is quite valid to put down the endorsement on the face of the instrument, though it is not advisable as it will make the document clumsy. When an instrument is negotiated by endorsement so many time that no space is left for further endorsements, the holder may attach a .slip, called allonge, to the instrument for further endorsements. In such a case, it is advisable to put down endorsement partly on the instrument and partly on the allonge so that the allonge may not be detached and attached to some other instrument. Form of Endorsement There is no prescribed form of endorsement; much depends upon the kind of endorsement that is put down. The usual form is as follows: Pay to Akhtar Hussain Mohammad Ismail However, the endorser is free to adopt any form he chooses provided it makes his intention of negotiation clear. For instance, the following rather unusual form of endorsement will be quite valid: I negotiate this instrument to Akhtar Hussain Mohammad Ismail The endorsement must be put down by the holder or his duly authorized agent. When an agent endorses an instrument on behalf of his principal, he must mention this fact in the endorsement lest he should be personally held liable thereon. If he has been given power-of-attorney to endorse negotiable instruments, he must put down the words per procuration or per pro before his signature. The endorsee may, if he likes, insist upon seeing the power-of-attorney in order to satisfy him that the agent has, in fact, got the authority of endorsement.

In the case of a firm, any partner may draw, make or endorse an instrument; but usually the work is divided among the partners and one or two partners are given the authority of making, drawing or endorsing the instrument. In case of a company, it is obvious that the company being an artificial person cannot endorse the instrument itself. This power is usually given to the director or secretary of the company. A minor may make, draw or endorse an instrument so as to bind all the persons who act upon the same but without incurring any liability there under. Delivery In order to constitute negotiation, endorsement must be followed by delivery. If the holder simply endorses the instrument but does not hand it over to the endorsee, it will not tantamount to negotiation. Moreover, the endorser must endorse and delivery the instrument with the intention of negotiating it. Delivery without intention of negotiation does not come to negotiation. If you hand over a Cheque for Rs. 30,000 to the National Bank of Pakistan for safe custody, obviously you have no idea of negotiating it while making its delivery and consequently it will not amount to negotiation. Essentials of a Valid Endorsement 1. 2. It must be made by the holder or maker or drawer, or It must be made on the back of face of the instrument or on the allonge

3. It must be signed by the endorser and the spelling of the signature must be the same as in the instrument. 4. The endorsement must be completed prior to delivery. Effect of Endorsement The effect of an endorsement and delivery of the document is to give several rights to the endorsee. The endorsee not only gets the right to possess the bill, but also the right to demand payment under the same on due date from the acceptor or maker, in case he fails to get the money from, then he may demand payment from the last endorser or previous endorser. He also obtains the right of further negotiation. He may, if he likes, negotiate the document to other persons or may collect the amount on its maturity.

Kinds of Endorsement
Endorsements are of various kinds which are as follows: 1. Blank or General Endorsement A blank or general endorsement is the one in which the endorser simply puts down his signature on the instrument, without putting down the name of the endorsee. The effect of blank endorsement is to make the instrument payable to bearer, so that property therein can thenceforward be transferred by mere delivery of the instrument. 2. Special Endorsement or Endorsement in Full If the endorsement contains not only the signature of the endorser but also the name of the endorsee, it is known as special endorsement or endorsement in full. If an instrument is endorsed in blank, its holder may, without signing his own name, by writing above the endorser's signature a direction to pay to any other person as endorsee, convert the endorsement in blank into an endorsement in full; and the holder does not thereby incur the responsibility of an endorser. 3. Restrictive Endorsement As a general rule, the holder of negotiable instruments has a right to transfer it to other by further negotiation. But an endorsement may restrict such right, when it is known as Restrictive Endorsement. Such an endorsement may (1) restrict or exclude the right of further negotiation by express words, e.g. Pay Ahmad Kamal only; or (2) merely constitute the endorsee an agent to endorse the instrument or to receive its contents for the endorser or for some other specified person e.g. Pay Akhtar Hussain for my use; Pay R.G. Saber or order for the account of Akhtar Hussain. The amount must be credited to Miss Akhtar Hussain. But the following endorsements, it should be remembered, do not restrict the right of negotiation: Pay Ahmad Mushtaq, Pay Sarfraz value in -account with the Commercial Bank, Pay the contents to P.C. Jain, being part of the consideration in a certain deed of assignment executed by him to the endorser and others. 4. Partial Endorsement A partial endorsement is one which means to transfer the document only for a part of its value. Ordinarily a partial endorsement is invalid; for the law expressly lays down that no writing on a negotiable instrument is valid for the purpose of negotiation if such writing purports to transfer only a part of the amount appearing to be due on the instrument. But where such amount has partly been paid, a note to that effect may be endorsed on the instrument which can then be negotiated for the balance. 5. Conditional Endorsement When the endorser, by express words in the endorsement. Makes his own liability thereon, or the right of the endorsee to receive the amount, due thereon, depend upon the happening of specified event, the endorsement, excludes his own liability on the instrument. 6. Sans Recourse Endorsement

"Sans Recourse" literally means recourse to me. A sans recourse endorsement, as such, is the one where the endorser, by express words in the endorsement, excludes his own liability on the instrument. Illustration, (a) The endorser of a negotiable instrument signs his name adding the words 'without recourse'. Upon this endorsement he incurs no liability. (b) A is the payees and holder of a negotiable instrument excluding personal liability by an endorsement "without recourse" he transfers the instrument to B and B endorses it to C, who endorses it to A. A is not only reinstated in his former rights but has the rights of an endorsee against B and C. 7. Facultative Endorsement When the endorser or the drawer waives some of the duties of the holder towards him, the endorsement is known as facultative endorsement. The duty which is generally waived is the duty of giving notice of dishonor in the event of the dishonor of the instrument. In this case, the following words are added to the signature of the endorser: The right of receiving notice of dishonor waived. 8. Forged Endorsement As a general rule, forgery does not give a good title. But an acceptor, who accepts an instrument knowing or having reason to believe that endorsement placed on it was forged, is not on that account relieved from his liability. If a Cheque bears a forged endorsement but the banker pays it in the ordinary course of business, in good faith and with the exercise, of proper caution, he is relieved from any liability arising out of the forged endorsement. The banker cannot know the signatures of all the endorsers; therefore, the utmost that can be expected of him is to see that all the endorsements are in order. If he has ascertained this fact and then pays the Cheque in ordinary course of business in good faith, he is free from all liabilities arising out of the forgery of signature. But if the signature of the drawer is forged, he will be held liable as he is expected to recognize the signature of the drawer. LIABILITIES OF PARTIES Every person, capable of contracting, may bind himself and be bound by the making, drawing, acceptance, endorsement, delivery and negotiation of a negotiable instrument. A minor may draw, endorse, deliver and negotiate such instrument so as to bind all parties except himself. The liabilities of the various parties to a negotiable instrument are as follows: Liability of the Maker of a Note The maker of a promissory note is the principal debtor thereon. He is bound to pay the amount thereof on maturity. In default of such payment, such maker is bound to compensate any party to the note for any loss or damaged sustained by him and caused by such default. The maker of a note cannot deny the validity of the instrument as originally made or drawn: nor can he deny the payee's capacity, at the date of the note to endorse the same. Liability of the Drawee or Acceptor The liability of the acceptor of a bill is just like the liability of the maker of a note; since both occupy almost the same position the acceptor is bound to pay the amount of the bill at maturity to the holder on demand. In default of such payment, such acceptor is bound to compensate any party to the bill for any loss or damage sustained by him and caused by such default. His liability is absolute, unconditional and independent of the death or insolvency of the drawer or of the fact of non-receipt of goods in respect of Which he accepted the instrument though a bill obtained by forgery cannot confer any title on its holder, yet the acceptor of a bill already endorsed is not relieved from liability by reason that such endorsement is forged, if he know or had reason to believe the endorsement to be forged when he accepted the bill. Again, the acceptor of a bill drawn in a fictitious name and payable to the drawer's order, is not by reason that such name is fictitious, relieved from liability to any holder in due course claiming under an endorsement by the same hand as the drawer's signature, and purporting to be made by the drawer. The difference between the liability of the maker of a note and that of the acceptor of a bill lies in the fact that while the maker is bound to pay according to the sense and purpose of the note, the acceptor is liable to pay according to the acceptance and is under no obligation other than that created by the acceptance. Liability of the Drawee Bank The drawee of a Cheque having sufficient funds of the drawer in his bands, properly applicable to the payment of such Cheque, must pay the Cheque when duly required to do so, and, in default of such payment, must compensate the drawer for any loss or damage caused by such default Liability of the Drawer The drawer of an instrument undertakes that the same shall be accepted by the drawee when presented for acceptance and be paid him when presented for payment on maturity. In case the bill is dishonored by non-acceptance or non-payment by the drawee or acceptor respectively, the drawer is liable to compensate the holder provided due notice of dishonor has been given, or received, by the drawer. The drawer remains the principal debtor on the bill so long as it is not accepted; on its acceptance he becomes a secondary debtor, the acceptor becoming the principal debtor. .As the drawer makes the instrument; he cannot deny its validity in its original form.

Liability of the Endorser The endorser enters into a contract with the endorsee and through him to all subsequent parties that the instrument shall be accepted when presented for acceptance, or paid when presented for payment on due date; and that in case of its dishonor, he shall compensate any subsequent holder for any loss or damage caused to him thereby, provided due notice of dishonor has been given to him. If the holder of the instrument weakens or destroys the endorser's right against a prior party, the endorser shall be discharged from his liability. The Order of Liability The order in which the liability of the various parties becomes effective is governed by the following rules. Every prior party to a negotiable instrument is liable thereon to a holder in due course until the instrument is duly satisfied. The maker of a promissory note or Cheque, the drawer of a bill of exchange until acceptance, and the acceptor, are in the absence of a contract to the contrary respectively liable thereon as principal debtors and the other parties thereto are liable thereon as sureties for the maker, drawer or acceptor, as the case may be. As between the parties as liable as sureties, each prior party is, in the absence of a contract to the contrary, also liable thereon as a principal debtor in respect of each subsequent party. A draws a bill payable to his own order on B, who accepts. A afterwards endorses the bill to C, C to D, and D to E. As between E and B, B is the principal debtor and C and D are his sureties. As between E and C, C is the principal and D is his surety. Liabilities of an Agent A person competent to contract may bind himself or be bound on a negotiable instrument by a duly authorized agent acting in his name. It should, however, be remembered that a general authority to transact business and to receive and discharge debts does not confer upon an agent the power of accepting or endorsing bills of exchange so as to bind his principal. Even an authority to draw bills of exchange does not of itself import an authority to endorse. An agent who signs his name on a negotiable instrument must indicate that he signs as agent; if he does not put that down, he will be liable personally on the instrument except to those who induced him to sign upon the belief that the principal only would be held liable. Ordinarily an agent should put down the words "For and on behalf of before the name of his principal; but if he is signing under power-of-attorney, he should put down per pro, or per procuration before the name of the principal. The secretary or a director of a company signing on behalf of the company must put down "On and behalf of....." so as to avoid personal liability which would occur in the absence of these words.