Chapter 8 of 10

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CMA Intermediate Business Laws and Ethics★ The Negotiable Instruments Act, 1881 — roughly 12 marks. The holder in due course, the kinds of crossing and section 138 are the reliably examined points, and the distinctions between the three instruments appear at almost every sitting.

The Negotiable Instruments Act, 1881

Why a piece of paper can carry a better title than the person who transferred it — promissory notes, bills and cheques, the holder in due course, crossings, dishonour, and the criminal liability under section 138.

⏱ 30 min readModerate difficulty✓ Free · exam-pattern aligned

Timed practiceMCQs from this chapter with instant scoring

FlashcardsFormulas & traps on spaced repetition

CMA Intermediate PYQsSolved previous-year questions

By the end of this chapter you'll be able to…

1Explain negotiability as an exception to nemo dat and state the characteristics of a negotiable instrument
2Recite the presumptions under section 118 and explain how they shift the burden of proof
3Define a promissory note, a bill of exchange and a cheque, and distinguish them on named bases
4Distinguish the kinds of crossing and state precisely what a 'not negotiable' crossing does
5Apply the four requirements of a holder in due course and list the privileges attaching to that status
6Distinguish a holder from a holder in due course and explain the consequences of the difference
7Identify the kinds of endorsement and their effects, including why a partial endorsement is invalid
8Compute maturity with days of grace and state when notice of dishonour is required and when dispensed with
9Apply all five conditions of section 138 to a sequence of dates and identify when the offence is complete

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Why this chapter matters in CMA Intermediate

Negotiability is a deliberate exception to a fundamental rule of property law: a transferee of a negotiable instrument who takes in good faith and for value can acquire a better title than his transferor had. Commerce requires it, because an instrument whose value depended on investigating the title of everyone through whose hands it had passed would be useless as a means of payment. Almost every question in the chapter is testing whether the candidate understands that exception — who gets the benefit of it, what strips it away, and what happens when the instrument is dishonoured.

Before you start — revise these

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Bills of Exchange, Final Accounts & Incomplete Records

The accounting treatment of bills — discounting, endorsement, dishonour and renewal — is the practical counterpart of the legal rules in this chapter.

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Contract Act: Performance, Breach & Special Contracts

The general law of contract supplies consideration, capacity and discharge; the Act adds only what is special to negotiable instruments.

The Negotiable Instruments Act, 1881

Weightage: Roughly 12 marks. The holder in due course, the types of crossing and section 138 are the reliably examined points, and the distinctions between the three instruments appear at almost every sitting.

What negotiability means

A debt is an ordinary chose in action. It can be assigned, but the assignee takes subject to every defect in the assignor's title and to every defence the debtor had against the assignor — nemo dat quod non habet applied to rights.

A negotiable instrument is different, and the difference is the whole point of the Act. Where an instrument is negotiable, a transferee who takes it in good faith and for value can acquire a better title than his transferor had. The paper carries the right, and the right travels clean.

This is a deliberate exception to a fundamental principle of property law, and it exists because commerce needs it. If every person taking a bill or a cheque had to investigate the title of everyone through whose hands it had passed, such instruments would be worthless as a means of payment or of raising credit. Negotiability makes the paper as good as money in the hands of an honest taker.

Section 13 defines a negotiable instrument as a promissory note, bill of exchange or cheque payable either to order or to bearer.

Characteristics

Freely transferable by delivery if payable to bearer, or by endorsement and delivery if payable to order.
The holder in due course obtains a title free from defects in the title of prior parties.
The holder can sue in his own name.
The instrument is payable to order or to bearer.
The property passes with the instrument.

Presumptions

Section 118 raises presumptions in favour of the holder until the contrary is proved, and reciting them is worth marks:

that the instrument was made or drawn for consideration;
that it bears the date on which it was made;
that a bill accepted was accepted within a reasonable time after its date and before maturity;
that every transfer was made before maturity;
that the endorsements appear in the order in which they are made;
that a lost instrument was duly stamped;
that the holder is a holder in due course.

Section 119 adds that in a suit on a dishonoured instrument, the court shall presume dishonour on proof of protest. These presumptions reverse the ordinary burden of proof and are what make an instrument commercially useful — the holder need not prove the underlying transaction.

The three instruments

Promissory note

Section 4 defines a promissory note as an instrument in writing, not being a banknote or currency note, 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.

Two parties: the maker, who promises, and the payee, who is to be paid. The maker's liability is primary and absolute, and it arises from the moment the note is made, because the person promising is the person liable.

Note that a promissory note cannot be made payable to bearer on demand — such an instrument would function as currency, and the Reserve Bank of India Act reserves that to the Reserve Bank.

Bill of exchange

Section 5 defines a bill of exchange as 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.

Three parties: the drawer who orders, the drawee on whom it is drawn, and the payee who is to be paid. On signing across the bill the drawee becomes the acceptor, and until acceptance he is under no liability, because an order given by one person cannot by itself impose an obligation on another.

Cheque

Section 6 defines a cheque as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. It includes the electronic image of a truncated cheque and a cheque in the electronic form.

A cheque is therefore a species of bill of exchange with two additional restrictions: the drawee must be a banker, and it must be payable on demand.

Distinguishing them

Promissory note against bill of exchange. A note contains a promise, a bill an order. A note has two parties, a bill three. In a note the maker is the debtor and is primarily liable; in a bill the drawer is a creditor and is only secondarily liable, the acceptor being primarily liable. A note requires no acceptance; a bill payable after sight must be accepted. A note cannot be drawn payable to bearer; a bill may be. In a note the maker cannot be the payee; in a bill the drawer and payee may be the same person.

Bill of exchange against cheque. A cheque is always drawn on a banker; a bill may be drawn on anyone. A cheque is always payable on demand; a bill may be payable on demand or after a period. A cheque requires no acceptance; a bill payable after sight does. A cheque may be crossed; a bill cannot. Days of grace are allowed on a time bill but never on a cheque. A cheque may be countermanded by the drawer; a bill cannot. Noting and protest are not usually necessary for a cheque.

Cheques and crossing

A cheque may be payable to bearer, in which case it is transferable by mere delivery, or payable to order, transferable by endorsement and delivery.

An open cheque may be presented at the counter and paid in cash. A crossed cheque cannot; it must be collected through a bank account. Crossing is therefore a security device: it creates a trail, because the payment can be traced to the account into which it was collected.

The kinds of crossing:

General crossing. Two parallel transverse lines across the face of the cheque, with or without the words "and company" or any abbreviation. The effect is that the cheque must be paid only to a banker, and so must be collected through an account.

Special crossing. The name of a banker written across the face, with or without the parallel lines. The cheque must be paid only to that banker or his agent for collection. It is more secure than a general crossing, because payment can be made only through one identified bank.

Restrictive crossing — "Account Payee". The words "account payee" or "account payee only" added to a crossing direct that the proceeds be credited only to the account of the named payee. Strictly, this is a direction to the collecting banker rather than a statutory form of crossing, but its practical effect is to make the cheque non-transferable in banking practice, and a collecting banker who credits it to any other account loses the statutory protection.

"Not negotiable" crossing. The addition of the words "not negotiable" to a crossing has an effect that must be stated precisely, because it is regularly misunderstood. The cheque remains transferable, but it ceases to be negotiable: a transferee cannot obtain a better title than his transferor had. So if a cheque marked "not negotiable" is stolen and transferred, the transferee gets no title however innocent he is. The words do not stop the cheque moving; they strip the paper of the one quality that made it special.

Who may cross. The drawer may cross a cheque generally or specially. Where it is uncrossed, the holder may cross it generally or specially; where crossed generally, he may cross it specially; and where crossed generally or specially, he may add the words "not negotiable". A banker to whom a cheque is crossed specially may again cross it specially to another banker as his agent for collection.

Holder and holder in due course

Holder (section 8) means any person entitled in his own name to the possession of the instrument and to receive or recover the amount due on it from the parties to it. A person who has stolen an instrument, or found it, is not a holder, because he is not entitled to possession in his own name.

Holder in due course (section 9) means any person who, for consideration, became the possessor of a promissory note, bill of exchange or cheque if payable to bearer, or the payee or endorsee thereof if payable to order, before the amount mentioned in it became payable, and without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title.

The four requirements, each of which must be satisfied:

He must be a holder, entitled to possession in his own name.
He must have taken the instrument for consideration — a donee cannot be a holder in due course.
He must have taken it before maturity. An overdue instrument carries notice of its own dishonour.
He must have taken it in good faith, without sufficient cause to believe any defect existed in the transferor's title.

Privileges of a holder in due course

The privileges are the substance of negotiability, and a full answer lists them:

He acquires a title free from defects in the title of prior parties, and may recover the full amount from any party liable.
Every prior party is liable to him until the instrument is duly satisfied.
No party can plead against him that the instrument was lost, or obtained by fraud or unlawful means, or for unlawful consideration.
Where an instrument was delivered conditionally or for a special purpose, that fact cannot be set up against him.
The maker of a note or acceptor of a bill cannot deny the validity of the instrument as originally made or drawn.
The acceptor of a bill drawn in a fictitious name cannot deny the drawer's signature or capacity to endorse.
A person who signed and delivered an inchoate stamped instrument is bound by it as completed, up to the amount covered by the stamp.
An endorser cannot deny the signature or capacity of any prior party.

Negotiation and endorsement

Negotiation is the transfer of an instrument so as to constitute the transferee the holder of it. An instrument payable to bearer is negotiated by delivery; an instrument payable to order is negotiated by endorsement and delivery.

Endorsement is the signing of the instrument by the holder for the purpose of negotiation, on the back or face, or on a slip of paper annexed to it (an allonge).

The kinds of endorsement:

Blank or general — the endorser signs his name only. The instrument becomes payable to bearer and is thereafter negotiable by delivery.
Full or special — the endorser adds a direction to pay to a specified person. Further negotiation requires that person's endorsement.
Restrictive — the endorsement restricts further negotiation, as "Pay X only", or constitutes the endorsee an agent, as "Pay X for my account".
Partial — an endorsement of part only of the amount is invalid and does not operate as a negotiation, since it would split the cause of action.
Conditional — the endorser makes his own liability conditional on the happening of an event. The condition affects only the endorser's liability; the transferee's title is unaffected.
Sans recourse — the endorser excludes his own liability by adding "without recourse".
Facultative — the endorser waives a right, most commonly by adding "notice of dishonour waived".

Maturity, dishonour and notice

A time instrument matures on the third day after the day on which it is expressed to be payable — the three days of grace. Where maturity falls on a public holiday, the instrument matures on the preceding business day. Days of grace are never allowed on a cheque or on any instrument payable on demand.

Dishonour by non-acceptance occurs where a bill is duly presented for acceptance and acceptance is refused, or where the drawee is incompetent to contract or the acceptance is qualified. Dishonour by non-payment occurs where the maker, acceptor or drawee makes default in payment on presentment.

On dishonour, the holder becomes entitled to sue the prior parties, but must first give notice of dishonour to all parties whom he seeks to make liable — otherwise those parties are discharged. Notice must be given within a reasonable time. It is dispensed with in defined cases, including where the party charged could not suffer damage for want of notice, where he cannot be found after due search, where he has waived notice, and where the drawer has countermanded payment.

Noting is the recording by a notary public of the fact of dishonour on the instrument or on a paper attached to it. Protest is the formal certificate of dishonour issued by the notary. Noting and protest are optional for inland instruments but compulsory for foreign bills where the law of the place requires it.

Section 138: dishonour of a cheque

This is the provision of the Act with the greatest practical importance, and it converts what would otherwise be a civil default into a criminal offence.

Section 138 provides that where a cheque drawn by a person on an account maintained by him is returned by the bank unpaid, either because the amount standing to the credit of that account is insufficient to honour the cheque, or because it exceeds the amount arranged to be paid from that account by an agreement made with the bank, that person is deemed to have committed an offence, punishable with imprisonment for a term which may extend to two years, or with fine which may extend to twice the amount of the cheque, or with both.

The conditions that must be satisfied, all of them:

The cheque must have been drawn for the discharge, in whole or in part, of any debt or other liability. A cheque given as a gift or as security for an undertaking that has not crystallised does not attract the section.
The cheque must be presented to the bank within its period of validity, which is three months from the date it bears.
The payee or holder in due course must make a demand for payment by notice in writing to the drawer within thirty days of receiving information from the bank about the return of the cheque as unpaid.
The drawer must fail to make payment within fifteen days of receipt of that notice.
The complaint must be made within one month of the date on which the cause of action arises — that is, on the expiry of the fifteen days.

The offence is committed only when the fifteen-day period expires without payment; until then the drawer has an opportunity to cure the default, and the section is structured to give him one.

Section 139 raises a presumption in favour of the holder that the cheque was received for the discharge of a debt or liability, and it is for the drawer to rebut it. Section 141 makes officers of a company responsible where the offence is committed by a company: every person who at the time was in charge of and responsible to the company for the conduct of its business is deemed guilty, subject to the defence that the offence was committed without his knowledge or that he exercised all due diligence to prevent it.

How this chapter is examined

Practical problems typically ask whether a person is a holder in due course and what he may recover; the effect of a particular crossing where a cheque has been stolen; whether the conditions of section 138 have been satisfied on a given sequence of dates; and the effect of a particular endorsement.

Descriptive and distinguishing questions ask for the distinction between a promissory note and a bill of exchange, between a bill and a cheque, between a holder and a holder in due course, and between the types of crossing. In every answer on crossing, state precisely what "not negotiable" does — the cheque remains transferable but the transferee can acquire no better title than his transferor — because that formulation is what separates a candidate who has understood negotiability from one who has memorised a list.

Key formulas & results

Everything to memorise for the exam hall, in one card. Screenshot this for revision.

What negotiability means

A transferee taking in good faith and for value can acquire a BETTER title than his transferor had — an exception to nemo dat quod non habet

Ordinary assignment passes the assignor's title subject to all its defects. Negotiability is what makes the paper as good as money in an honest taker's hands.

Holder in due course (section 9)

Took FOR CONSIDERATION + as possessor if payable to bearer, or payee/endorsee if payable to order + BEFORE maturity + WITHOUT sufficient cause to believe any defect existed in the transferor's title

All four are required. A donee, or a person taking an overdue instrument, or one on notice of a defect, is a holder but not a holder in due course.

'Not negotiable' crossing

The cheque REMAINS TRANSFERABLE but ceases to be NEGOTIABLE — a transferee can acquire no better title than his transferor had

The words do not stop the cheque moving; they strip it of the one quality that made it special. This precise formulation is what earns the marks.

Promissory note versus bill of exchange

Note: unconditional promise, 2 parties, maker primarily liable, no acceptance needed, cannot be payable to bearer. Bill: unconditional order, 3 parties, acceptor primarily liable, acceptance needed if payable after sight, may be payable to bearer.

The difference in direction explains everything: a promise binds the promisor at once, while an order binds nobody until the drawee accepts.

Cheque versus bill

A cheque is drawn on a banker, is always payable on demand, needs no acceptance, may be crossed, gets no days of grace, and may be countermanded

A cheque is a species of bill with two added restrictions — the drawee must be a banker and it must be payable on demand.

Days of grace

A time instrument matures on the third day after the day it is expressed to be payable; if that day is a public holiday it matures on the PRECEDING business day

Days of grace are never allowed on a cheque or on any instrument payable on demand.

Section 138 — the five conditions

(1) cheque drawn for a debt or liability, (2) presented within its validity of three months, (3) written demand within 30 days of the bank's information of return, (4) drawer fails to pay within 15 days of receiving the notice, (5) complaint within one month of expiry of those 15 days

The offence is complete only when the 15 days expire without payment — the structure deliberately gives the drawer a chance to cure.

Section 138 punishment

Imprisonment up to two years, or fine up to twice the amount of the cheque, or both

Section 139 presumes the cheque was received for a debt or liability, and it is for the drawer to rebut that presumption.

CMA Intermediate test series

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The Negotiable Instruments Act, 1881 shows up in every CMA Intermediate paper — sit a timed one and find out where you actually stand.

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Traps CMA Intermediate sets — and how to dodge them

These are the exact option-traps and misreads that cost marks under negative marking.

WATCH OUT

✗ Saying a 'not negotiable' crossing makes a cheque non-transferable

✓ The cheque remains fully transferable. What it loses is negotiability — the transferee can acquire no better title than his transferor had, so a taker from a thief gets nothing however innocent.

WATCH OUT

✗ Treating any holder as a holder in due course

✓ A holder is merely a person entitled in his own name to possession and to recover the amount. A holder in due course must additionally have taken for consideration, before maturity, and in good faith without cause to believe any defect existed.

WATCH OUT

✗ Allowing a donee of an instrument to claim holder-in-due-course privileges

✓ Consideration is one of the four requirements. A person who received the instrument as a gift is a holder and can sue on it, but takes subject to all defects in his transferor's title.

WATCH OUT

✗ Treating an instrument taken after maturity as giving a clean title

✓ Taking before the amount became payable is a requirement of section 9. An overdue instrument carries notice of its own dishonour, so a person taking it cannot be in good faith about the transferor's title.

WATCH OUT

✗ Allowing days of grace on a cheque

✓ Days of grace apply only to time instruments. A cheque is always payable on demand and gets none, and neither does any other demand instrument.

WATCH OUT

✗ Saying a maturity date falling on a holiday moves to the next working day

✓ It moves to the preceding business day. The holder should not be kept out of payment by a holiday, while the payer must still be able to pay on a working day.

WATCH OUT

✗ Treating a partial endorsement as a valid transfer of part of the amount

✓ A partial endorsement is invalid and does not operate as a negotiation, because it would split the cause of action and expose the payer to multiple suits on one instrument.

WATCH OUT

✗ Counting the section 138 notice period from the date of the cheque or of dishonour by the bank

✓ The thirty days run from receipt by the payee of information from the bank about the return of the cheque unpaid. The fifteen days then run from the drawer's receipt of the notice.

WATCH OUT

✗ Filing a section 138 complaint immediately on dishonour

✓ The offence is not complete until the fifteen days after the notice expire without payment. A complaint before that is premature, and it must be filed within one month of that expiry.

WATCH OUT

✗ Saying a promissory note may be made payable to bearer on demand

✓ It may not. Such an instrument would circulate as currency, and the Reserve Bank of India Act reserves the issue of bearer instruments payable on demand to the Reserve Bank.

Exam-pattern practice

PYQ-style questions with full solutions. Work through them as a readiness check — mark yourself honestly and get your gap report at the end.

Readiness check

Are you exam-ready for The Negotiable Instruments Act, 1881?

15 problems from this chapter. Try each one, reveal the worked solution, mark yourself honestly — get your gap report at the end.

15 questions~11 min

5-minute revision

The whole chapter, distilled. Read this the night before the exam.

•Negotiability lets a good-faith taker for value acquire a better title than his transferor had — an exception to nemo dat.
•Section 118 presumes consideration, date, timely acceptance, transfer before maturity, order of endorsements, due stamping, and that the holder is a holder in due course.
•A note is a promise with two parties; a bill is an order with three, and the drawee is not liable until he accepts.
•A promissory note cannot be made payable to bearer on demand.
•A cheque is a bill drawn on a banker and payable on demand; it gets no days of grace and may be crossed and countermanded.
•A holder in due course must take for consideration, before maturity, and in good faith without cause to believe in any defect.
•A 'not negotiable' crossing leaves the cheque transferable but denies the transferee a better title than his transferor had.
•An 'account payee' crossing directs the collecting banker to credit only the named payee's account.
•A blank endorsement makes the instrument payable to bearer; a partial endorsement is invalid because it would split the cause of action.
•A 'sans recourse' endorser transfers title but excludes his own liability on dishonour.
•Maturity falling on a public holiday moves to the preceding business day, not the following one.
•Failure to give notice of dishonour discharges the parties not notified, but never the party primarily liable.
•Section 138 requires: a debt or liability, presentation within validity, notice within 30 days, non-payment within 15 days, complaint within one month.
•The section 138 offence is complete only when the fifteen days expire without payment.
•Section 139 presumes the cheque was for a debt or liability; the drawer must rebut it.

CMA Intermediate question blueprint

How this topic is asked, tier by tier — so you can prep to the pattern.

Typical weightage: 12

Exam-hall strategy

Battle-tested tips from mentors and toppers for this topic under the sectional clock.

State the precise effect of a 'not negotiable' crossing in one sentence — transferable but not negotiable — since that formulation is what earns the marks.
In holder-in-due-course problems, test all four requirements of section 9 in order and say which fail.
Check section 53 before concluding against a later holder — a person deriving title through a holder in due course takes the cleansed title.
For section 138 problems, tabulate the dates and mark each of the five conditions as satisfied or not before concluding.
Compute maturity by adding days of grace first, then applying the preceding-business-day rule if a holiday intervenes.
In distinguishing questions, organise on named bases and end with a consequence, such as who is primarily liable or whether criminal liability attaches.
Distinguish a stolen bearer cheque from a forged endorsement — the outcomes are opposite and questions are set on the contrast.

Beyond the exam

Where this skill shows up in the job you're competing for — and in life.

Section 138 prosecutions are among the highest-volume cat…

Section 138 prosecutions are among the highest-volume categories of criminal litigation in India, and the fifteen-day cure window is why demand notices are drafted and served with such care.

The combined 'Account Payee

The combined 'Account Payee, Not Negotiable' crossing is standard practice on cheques of any significance, because it both prevents wrongful collection and defeats any downstream title if collection nonetheless occurs.

Bill discounting and the endorsement of trade bills in su…

Bill discounting and the endorsement of trade bills in supply chains depend entirely on the holder-in-due-course protection, which is what makes a bill acceptable as security.

The presumptions in section 118 are why a suit on a disho…

The presumptions in section 118 are why a suit on a dishonoured cheque proceeds on the instrument alone, without the plaintiff having to prove the underlying transaction.

Where else this topic is tested

Prepare once, score in every exam that asks it.

CA Intermediate Paper 2 — Corporate and Other Laws, which covers the Negotiable Instruments Act in greater depth

CA Foundation Paper 1 — Accounting, whose bills of exchange chapter is the accounting counterpart

CS Executive — Jurisprudence, Interpretation and General Laws

CMA Foundation — Fundamentals of Business Laws

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Questions aspirants ask

Pulled from the Q&A community and mentor sessions.

No, and this is the point most often got wrong. The cheque remains fully transferable and each transferee becomes a holder able to sue in his own name. What is withdrawn is negotiability — the transferee cannot get a better title than his transferor had. So a taker from a thief gets nothing, however innocent, because the thief had nothing.

No. Consideration is one of the four requirements of section 9. A donee is a holder and can sue on the instrument, but takes subject to all defects in his transferor's title. He may, however, benefit from section 53 if he derives title through a holder in due course, since that section gives him the rights of that holder against prior parties.

Because the holder should not be kept out of his money by a holiday, while the payer must still be able to make payment on a working day. Moving the date forward would delay the holder; moving it back achieves both objects. The rule catches candidates who assume the ordinary convention of deferring to the next working day.

On the expiry of fifteen days from the drawer's receipt of the demand notice, without payment being made. Not on dishonour, and not on service of the notice. The section deliberately gives the drawer a chance to cure, and a complaint filed before that fifteen-day period ends is premature. The complaint must then be filed within one month of that expiry.

It depends on whether a legally enforceable debt or liability existed when the cheque was presented. A cheque securing a liability that has crystallised — a loan that has fallen due and is unpaid — attracts the section notwithstanding the label. A cheque securing a contingent obligation that never arose does not, because an essential ingredient is missing. Section 139 places the burden of showing this on the drawer.

Nothing passes. A forged endorsement is a nullity, so no title moves through it and even the most innocent taker for value acquires nothing and cannot be a holder in due course. This differs sharply from a stolen bearer cheque, where an honest taker for value does become a holder in due course and gets a good title.