Subject: Business Law

Topic: Negotiable Instruments

Submitted to: Brig. (R) Muhammad Saleem
Submitted by: M. Ahmad Ali
Roll No: L-21206
Class: MBA-4

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 Negotiable Instruments
A negotiable instrument is a signed document that promises a sum of payment to a specified
person or the assignee. In other words, it is a formalized type of IOU: A transferable, signed
document that promises to pay the bearer a sum of money at a future date or on-demand. The
payee, who is the person receiving the payment, must be named or otherwise indicated on the
instrument.
Because they are transferable and assignable, some negotiable instruments may trade on a
secondary market.
 Negotiable instruments are transferable in nature, allowing the holder to take the funds as
cash or use them in a manner appropriate for the transaction or according to their preference.
 Common examples of negotiable instruments include cheques, money orders, and promissory
notes.

Examples of Negotiable Instruments

 One of the more common negotiable instruments is the personal cheque. It serves as a draft,
payable by the payer’s financial institution upon receipt in the exact amount specified.
Similarly, a cashier’s cheque provides the same function; however, it requires the funds to be
allocated, or set aside, for the payee prior to the cheque being issued.
 Money orders are similar to cheques but may or may not be issued by the payer’s financial
institution. Often, cash must be received from the payer prior to the money order being
issued. Once the money order is received by the payee, it can be exchanged for cash in a
manner consistent with the issuing entity's policies.
 Other common types of negotiable instruments include bills of exchange, promissory notes
and drafts.

Promissory Note
A promissory note is a financial tool used to put the terms of a loan in writing. The note spells
out the amount borrowed by one party, as well as how and when the money will be paid back. A
promissory note is a legal contract that binds the borrower by law. If the borrower fails to repay
the money according to the terms of the note, the lender may file a civil lawsuit to obtain a
judgment, and possibly take additional action, to get his money back.
A promissory note is a written and signed contract in which one party promises to pay a
specified amount of money to the other party. The terms of a promissory can be tailored to the
parties’ needs, as far as the amount borrowed, whether interest will be charged, the schedule or
date by which the money must be repaid, and any other needed particulars.

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There is no requirement that a promissory note be made on a certain type of paper or document,
or that it contains complex language, though it is important to be as specific as possible. In fact, a
promissory written and signed on a scrap piece of paper, back of a napkin, or even in an email or
text message, is just as valid as a note drawn up by a lawyer.

Essentials of a promissory note

An instrument to be a promissory note must fulfill the following essentials: -
1. It must be in writing
2. The promise to pay must be express
3. The promise to pay must be unconditional
4. It must be signed by the maker
5. The maker must be certain
6. Promise must be to pay a certain sum
7. The promise should be to pay money and money only
8. The payee must be certain

Types of Promissory Note

Though every good promissory note contains certain elements, there are several types of
promissory note. These notes are largely classified by the type of loan issued, or purpose for the
loan. All of the following types of promissory note are legally binding contracts.
 Personal Promissory Note
 Commercial Promissory Note
 Real Estate Promissory Note
 Investment Promissory Notes

Informal Promissory Note Example

Mike and John are having a beer at the local pub after work when John mentioned he needed to
come up with $1,000 to send to his ex-wife by the end of the week, or he would be in trouble
with the family court judge. Mike offered to lend John the money, if John could repay it by the
15th of the following month. John agreed, and Mike grabbed a cardboard drink coaster, and
borrowed a pen from a waitress. He wrote the following on the coaster:
“I, John Smith, borrowed $1,000 Mike Brown, and promise to repay the entire amount by March
15, 2015.”
He had John sign the coaster and stuck it in his pocket. When John had not repaid the money by
July, and avoided making a commitment to a payment arrangement, Mike filed a civil lawsuit. At
the small claims court trial, Mike gives the promissory note drink coaster, with John’s signature
on it, to the judge. The judge rules that the coaster is a valid contract, and that John must repay
Mike the entire amount of the loan immediately.

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 Bill of Exchange
Bill of exchange means a bill drawn by a person directing another person to pay the specified
sum of money to another person. A bill of exchange is of real use if it is accepted by the person
directed to pay the amount. In general practice, the seller gives a credit period to the buyer on
selling goods or on providing services. But sometimes, the seller is not in a position to offer
credit period to purchaser and purchaser also will not be in a position to pay immediately.
In such a case, the seller will like that the purchaser shall give a promise in writing to pay the
amount on a certain date.
This written promise then turns into valuable instruments of credit when this written promise is
made in proper form and is properly stamped. These written instruments are often accepted by
banks and we can advance money against them. Also, we can endorse this instrument i.e. can
pass to another person.

Essentials of Bills of Exchange

After understanding the bills of exchange introduction and parties above, let’s see their
essentials. A typical bill of exchange contains the following elements:

 A bill of exchange an instrument in writing.

 It is drawn and signed by the maker i.e. drawer of the bill.
 It is drawn on a specific person i.e. drawee, to pay the specified amount.
 Contains an unconditional order to a person i.e. drawee.
 To make an instrument of value the drawee must accept it.
 The specified amount is payable to the person whose name is mentioned in the bill or to his
order or to the bearer.
 It specifies the date by which amount should be paid.
 Payment of the bill must be in the legal currency of the country.
 It must be properly stamped.

Parties to Bills of Exchange

The following parties play a role in bills of exchange:
 Drawer: This is basically the person who draws the bill.
 Drawee: In contrast to the drawer, the drawee is the person in whose favor the bill is drawn.
 Acceptor: This is the person who accepts a bill of exchange. Generally, the acceptor is the
drawee but a stranger may accept it too.
 Payee: Either the drawee or a stranger may be a payee, which is the person to whom bills are
payable.
 Holder: This is generally the payee of the bill. It could also be some other person to whom
the payer endorses the bill. In case of bearer bills, the bearer himself is the holder.
 Endorser: The holder becomes an endorser when he endorses the bill to another person.
 Endorsee: This is the person to whom a bill is endorsed by the endorser.

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Forms of Bills of Exchange
The following are some common forms of bills of exchanges that the Negotiable Instruments Act
recognizes:
a) Inland Bills
A bill of exchange may be an inland instrument under two conditions. Firstly, the bill must be
drawn as well as payable within India. Secondly, it may also be drawn in India upon an India
resident but payable in a foreign country.
b) Foreign Bills
All bills that are not inland bills are foreign bills by default. Generally, foreign bills require three
copies and different rules govern them.
c) Trade Bills
A bill of exchange that comes into play during a genuine trade transaction is a trade bill. For
example, when A sells goods to B, he may draw a bill directing B to pay later on. This bill will
mention the purchase price as well as the specific date on which it is payable.
d) Accommodation Bills
Accommodation bills are different from trade bills because they do not involve any transactions
of trade. Hence, consideration for the exchange of goods or services is not important here. In
accommodation bills, one person lends his name to oblige a friend or some other person. This is
basically similar to loan transactions.

Example of a Bill of Exchange Transaction

Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car Supply XYZ draws
a bill of exchange, becoming the drawer and payee in this case, for $25,000 payable in 90 days.
Company ABC becomes the drawee and accepts the bill of exchange and the goods are shipped.
In 90 days, Car Supply XYZ will present the bill of exchange to Company ABC for payment.
The bill of exchange was an acknowledgment created by Car Supply XYZ, which was also the
creditor in this case, to show the indebtedness of Company ABC, the debtor.

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 Cheque
A cheque is a written, dated, and signed instrument that directs a bank to pay a specific sum of
money to the bearer. The person or entity writing the cheque is known as the payor or drawer,
while the person to whom the cheque is written is the payee. The drawee, on the other hand, is
the bank on which the cheque is drawn.
Cheques may be cashed or deposited. When the payee presents a cheque to a bank or other
financial institution to negotiate, the funds are drawn from the payor’s bank account. It is another
way to instruct the bank to transfer funds from the payor’s account to the payee or the payee’s
account. Cheques are generally written against a chequeing account, but they can also be used to
negotiate funds from a savings or other type of account.
 It is another way to instruct a bank to transfer funds from the payor’s account to the payee or
that person's account.
 Cheques are generally seen as a more secure way of transferring money.
 Cheque features include the date, the payee line, the amount of the cheque, the payor’s
endorsement, and a memo line.
 Types of cheques include certified cheques, cashier’s cheques, and payroll cheques, also
called paycheques.

Essentials of cheque
There are a number of lines that need to be filled in by the payor:
 The date is written on the line on the top right-hand corner of the cheque.
 The payee’s name goes on the first line in the center of the cheque. This is indicated by the
phrase "Pay to the Order Of."
 The amount of the cheque in a dollar figure is filled out in the box next to the payee’s name.
 The amount written out in words goes on the line underneath the payee’s name.
 The payor signs the cheque on the line on the bottom right hand corner of the cheque. The
cheque must be signed to be considered valid.

Types of Checks
Checks can be used for several different purposes.
 Certified check
One example is a certified check, which verifies that the drawer’s account has enough funds
to honor the amount of the check. In other words, the check is guaranteed not to bounce. To
certify a check, it must be presented at the bank on which it is drawn, at which time the bank
will ascertain its authenticity with the payor.

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 Cashier's check
A cashier’s check is guaranteed by the banking institution and signed by a bank cashier,
which means the bank is responsible for the funds. This type of check is often required in
large transactions, such as buying a car or house.
 Payroll check
Another example is a payroll check, or paycheck, which an employer issues to compensate
an employee for his or her work. In recent years physical paychecks have given way to direct
deposit systems and other forms of electronic transfer.

Parties to a Cheque
Generally, there are two parties to a cheque. These include the drawer and the drawee. While the
drawer is the person who draws the cheque, the drawee is the banker on whom it is drawn.
Apart from these, there can also be a payee who is liable to pay the amount on the cheque.
Furthermore, there can also be a holder who is generally the original payee. When the holder
endorses the cheque to somebody, he becomes the endorsee. On the contrary, an endorsee is a
person to whom the cheque is endorsed.

Difference between order cheque and bearer cheque

 Bearer Cheque
A Bearer Cheque is one which is payable to the presenter or bearer of the cheque. In case of a
bearer cheque, no endorsement is required to encash it. In order words, the identity of the
presenter of the cheque is not insisted by the banker. Stated differently, a bearer cheque can
be freely transferred from one person to another person by merely delivery. All SB cheques
issued by banks in India are bearer cheques as the word ‘bearer’ printed on it. Further, when
a cheque is originally made payable to bearer, it continues to be a bearer cheque, even if it
contains an endorsement on the back of the cheque!! Hence it is said that “Once a bearer
cheque, always a bearer cheque”.

 Order Cheque
An Order Cheque is, on the other hand, payable to a certain person or to his order. In case of
an order cheque, it is transferable by endorsement and delivery. In other words, the cheque
should be first endorsed and then be delivered to the person to whom it is endorsed.
Therefore, a paying banker, before making payment of an order cheque, can make necessary
enquiries about the identity of the payee, whenever, he has doubt in his mind that the
presenter is not entitled to receive the payment.
In case it is a bearer cheque, it can be converted into an order cheque by striking off the word
bearer on the cheque.

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Differences between Promissory Note and Bill of Exchange:
Basis of Bill of Exchange Promissory Note
Comparison
Definition A negotiable instrument issued to A negotiable instrument issued by
order the debtor to pay the creditor the debtor with a written promise to
a certain sum of money within a pay the creditor a certain amount
specific date or on demand. within a specific date or on demand.
Issued by Creditor Debtor
Parties Three parties involved i.e. a Two parties involved i.e. a
Involved drawer, the drawee and a payee. drawer/maker and the payee
Acceptance Drawee needs to accept the bill of No acceptance required from the
exchange before payment. drawee
Liability Liability of drawer is secondary Liability of drawer is primary and
and conditional. absolute.
Dishonoring of Notice served to all the concerned No notice served to the drawer in
instrument parties involved in the transaction case of dishonoring the instrument.
on dishonoring the instrument.
Copies Bill of exchange can have copies. The promissory note allows no
copies.
Is it Payable to Yes, the same person can be The same person cannot be drawer
drawer/maker drawer and payee. and payee.

Differences between Bill of Exchange and Cheque:

Basis for Cheque Bill of exchange
comparison
Meaning A document used to make easy A written document that shows the
payments on demand and can be indebtedness of the debtor towards
transferred through hand delivery the creditor.
is known as cheque.
Validity Period 3 months Not applicable
Payable to Always Cannot be made payable on demand
bearer or
demand
Grace days Not Applicable, as it is always 3 days of grace are allowed.
payable at the time of presentment.
Acceptance A cheque does not require Bill of exchange needs to be
acceptance. accepted.
Stamping No such requirement. Must be stamped.
Crossing Yes No
Drawee Bank Person or Bank
Noting or If the cheque is dishonored it If a bill of exchange is dishonored it
protesting cannot be noted or protested can be noted or protested.

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Differences between Promissory Note and Cheque:
Basis for Cheque Promissory Note
comparison
Order and It contains order to pay. A promissory note contains promise
Promise to pay.
Number of In case of cheque there may be In case of promissory note are only
Parties three parties, the drawer, drawee two parties, the maker and the payee.
and payee.
Object Cheque is used because it is a It is used for receiving and giving
simple and easy medium of credit.
exchange and serving of metallic
money.
Crossing A cheque may be crossed. A pro-note cannot be crossed.
Payable to A cheque is often drawn as A pro-note cannot be drawn payable
Bearer payable to bearer. to bearer.
Stop Payment Its payment can be stopped by A pro-note payment cannot be
giving the notice to the bank. stopped if once issued.
Liability Nature In case of cheque when it is In case of promissory note liability is
dishonored, the drawer is liable. primary.
Use of Form It is drawn on a printed form Promissory note may be drawn on
issued by a particular bank. any paper and there is no need of any
particular form.
Drawee A cheque is always drawn to a A promissory note can be drawn on
particular bank where account is any person.
available.
Drawer and In case of cheque drawee and In case of pro-note there are two
Payee payee can be the same person. parties and maker cannot be the
payee.

Conclusion
Even though the bill of exchange, promissory note and cheque have differences but also they
have some similarities that both contains when they have made, the law requires that both of the
instruments must be unconditional, made in writing, must be signed by the person making it, the
drawer or maker must be certain person and the sum amount must be certain, both of these have
been provides in the law that governing these instrument in Tanzania that is The Bill of
Exchange. So, any instrument either promissory note, bill of exchange or cheque must follow the
formality as the law provides.

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