Definition of Negotiable Instrument
A negotiable instrument is a written document that guarantees the payment of a specific amount of money, either on demand or at a future date, with the payer’s name mentioned. It is transferable from one person to another, enabling the holder to claim the right of payment.
Meaning of Negotiable Instrument in Detail
The term "negotiable" means transferable, while "instrument" refers to a written document. Together, a negotiable instrument is a document that can be freely transferred by delivery or endorsement, giving the transferee the right to receive payment. Common examples include cheques, promissory notes, and bills of exchange. These instruments play a crucial role in trade and commerce as they facilitate credit transactions and provide legal assurance of payment.
Types of Negotiable Instruments
Promissory Note: A written promise by one party to pay another a definite sum of money either on demand or at a specific date.
Bill of Exchange: An order made by the drawer directing the drawee to pay a certain sum to a specified person.
Cheque: A written order directing a bank to pay a specific amount from the drawer’s account to the person named.
Formula or Calculation (if applicable)
While negotiable instruments don’t have a strict formula, calculation comes into play for:
Maturity Date of a Bill of Exchange:
Example Calculation
If a bill of exchange is drawn on 1st January 2025 for 3 months, then:
Maturity Date = 1 January + 3 months (1 April) + 3 grace days = 4 April 2025.
Journal Entry with Example
If Mr. A issues a promissory note in favor of Mr. B worth ₹50,000:
In the books of Mr. B (Holder):
Bills Receivable A/c Dr. ₹50,000
To Mr. A A/c ₹50,000
In the books of Mr. A (Maker):
Mr. B A/c Dr. ₹50,000
To Bills Payable A/c ₹50,000
Detailed Illustration
Suppose Mr. X sells goods worth ₹1,00,000 to Mr. Y and draws a bill for 3 months. Mr. Y accepts the bill.
In Mr. X’s books:
Bills Receivable A/c Dr. ₹1,00,000
To Mr. Y A/c ₹1,00,000
At maturity, if the bill is honored:
Bank A/c Dr. ₹1,00,000
To Bills Receivable A/c ₹1,00,000
In Mr. Y’s books:
Mr. X A/c Dr. ₹1,00,000
To Bills Payable A/c ₹1,00,000
At maturity:
Bills Payable A/c Dr. ₹1,00,000
To Bank A/c ₹1,00,000
Key Features of Negotiable Instruments
Freely transferable.
Written and signed by maker/drawer.
Involves unconditional promise or order to pay.
Payable in money only.
Holder in due course has legal rights.
Importance in Business
Facilitates trade and credit transactions.
Provides security and legal assurance of payment.
Improves liquidity in business.
Acts as an alternative to cash.
Advantages and Disadvantages
Advantages:
Provides credit facility.
Legal protection under the Negotiable Instruments Act.
Reduces cash handling.
Disadvantages:
Risk of dishonor.
Chances of forgery or fraud.
Requires legal proceedings in case of default.
Usage
Used in both domestic and international trade.
Helps in short-term financing.
Commonly used by individuals, firms, and companies for payments.
Case Studies
Case 1: Vijay Mallya’s Loan Default: Banks relied on promissory notes and cheques which were dishonored, leading to litigation under the Negotiable Instruments Act.
Case 2: Infosys Employee Payments: Salary cheques issued by the company are a practical example of negotiable instruments.
Practical Example
If a company issues a post-dated cheque of ₹5,00,000 to a supplier, the supplier can either wait until maturity or endorse it to another creditor to settle debts.
Common Mistakes or Misunderstandings
Believing that all signed documents are negotiable instruments.
Ignoring legal requirements like signature and date.
Assuming that dishonor doesn’t have legal consequences.
Real-Life Applications and Legal Implications
Cheques used in day-to-day transactions.
Bills of exchange in international trade.
Promissory notes in business loans.
Legal protection under the Negotiable Instruments Act, 1881 ensures payment or legal remedy in case of dishonor.
FAQs
Q1. What are the main types of negotiable instruments?
Cheques, bills of exchange, and promissory notes.
Q2. Who regulates negotiable instruments in India?
The Negotiable Instruments Act, 1881.
Q3. Can a dishonored cheque lead to jail?
Yes, under Section 138 of the Negotiable Instruments Act.
Q4. Is digital payment a negotiable instrument?
No, digital transfers like UPI or NEFT are not negotiable instruments.
Q5. Can negotiable instruments be endorsed?
Yes, they can be endorsed and transferred to another party.
Expert Tip from Learn with Manika
Always record negotiable instruments properly in your books of accounts and track their maturity dates. Dishonor can impact creditworthiness and business relationships.
Related Terms
- Bills Receivable
- Bills Payable
- Endorsement
- Dishonor of Cheque
- Holder in Due Course