Unit 1.

Different Payment Methods used in Banking System

The Reserve Bank of India as the central bank of India has been playing a developmental role
and has taken several initiatives for Safe, Secure, Sound, Efficient, Accessible and
Authorised payment systems in the country.

The Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), a
sub-committee of the Central Board of the Reserve Bank of India is the highest policy
making body on payment systems in the country. The BPSS is empowered for authorising,
prescribing policies and setting standards for regulating and supervising all the payment and
settlement systems in the country.

In India, the payment and settlement systems are regulated by the Payment and Settlement
Systems Act, 2007 (PSS Act) which was legislated in December 2007. The PSS Act as well
as the Payment and Settlement System Regulations, 2008 framed thereunder came into effect
from August 12, 2008. In terms of Section 4 of the PSS Act, no person other than the Reserve
Bank of India (RBI) can commence or operate a payment system in India unless authorised
by RBI. Reserve Bank has since authorised payment system operators of pre-paid payment
instruments, card schemes, cross-border in-bound money transfers, Automated Teller
Machine (ATM) networks and centralised clearing arrangements.
(http://www.rbi.org.in/Scripts/PublicationsView.aspx?id=12043)

Payment Systems

Paper-based Payments

Use of paper-based instruments (like cheques, drafts, and the like) accounts for nearly 60% of
the volume of total non-cash transactions in the country. In value terms, the share is presently
around 11%. This share has been steadily decreasing over a period of time and electronic
mode gained popularity due to the concerted efforts of Reserve Bank of India to popularize
the electronic payment products in preference to cash and cheques.
Since paper-based payments occupy an important place in the country, Reserve Bank had
introduced Magnetic Ink Character Recognition (MICR) technology for speeding up and
bringing in efficiency in processing of cheques.

Later, a separate High Value Clearing was introduced for clearing cheques of value Rupees
one lakh and above. This clearing was available at select large centers in the country (since
discontinued). Recent developments in paper-based instruments include launch of Speed
Clearing (for local clearance of outstation cheques drawn on core-banking enabled branches
of banks), introduction of cheque truncation system (to restrict physical movement of
cheques and enable use of images for payment processing), framing CTS-2010 Standards (for
enhancing the security features on cheque forms) and the like.

While the overall thrust is to reduce the use of paper for transactions, given the fact that it
would take some time to completely move to the electronic mode, the intention is to reduce
the movement of paper – both for local and outstation clearance of cheques.

Electronic Payments

The initiatives taken by RBI in the mid-eighties and early-nineties focused on technology-
based solutions for the improvement of the payment and settlement system infrastructure,
coupled with the introduction of new payment products by taking advantage of the
technological advancements in banks. The continued increase in the volume of cheques
added pressure on the existing set-up, thus necessitating a cost-effective alternative system.

Electronic Clearing Service (ECS) Credit

The Bank introduced the ECS (Credit) scheme during the 1990s to handle bulk and repetitive
payment requirements (like salary, interest, dividend payments) of corporates and other
institutions. ECS (Credit) facilitates customer accounts to be credited on the specified value
date and is presently available at all major cities in the country.

During September 2008, the Bank launched a new service known as National Electronic
Clearing Service (NECS), at National Clearing Cell (NCC), Mumbai. NECS (Credit)
facilitates multiple credits to beneficiary accounts with destination branches across the
country against a single debit of the account of the sponsor bank. The system has a pan-India
characteristic and leverages on Core Banking Solutions (CBS) of member banks, facilitating
all CBS bank branches to participate in the system, irrespective of their location across the
country.

Electronic Clearing Service (ECS) Debit

The ECS (Debit) Scheme was introduced by RBI to provide a faster method of effecting
periodic and repetitive collections of utility companies. ECS (Debit) facilitates consumers /
subscribers of utility companies to make routine and repetitive payments by ‘mandating’
bank branches to debit their accounts and pass on the money to the companies. This
tremendously minimizes use of paper instruments apart from improving process efficiency
and customer satisfaction. There is no limit as to the minimum or maximum amount of
payment. This is also available across major cities in the country.

Electronic Funds Transfer (EFT)

This retail funds transfer system introduced in the late 1990s enabled an account holder of a
bank to electronically transfer funds to another account holder with any other participating
bank. Available across 15 major centers in the country, this system is no longer available for
use by the general public, for whose benefit a feature-rich and more efficient system is now
in place, which is the National Electronic Funds Transfer (NEFT) system.

National Electronic Funds Transfer (NEFT) System

In November 2005, a more secure system was introduced for facilitating one-to-one funds
transfer requirements of individuals / corporates. Available across a longer time window, the
NEFT system provides for batch settlements at hourly intervals, thus enabling near real-time
transfer of funds. Certain other unique features viz. accepting cash for originating
transactions, initiating transfer requests without any minimum or maximum amount
limitations, facilitating one-way transfers to Nepal, receiving confirmation of the date / time
of credit to the account of the beneficiaries, etc., are available in the system.

Real Time Gross Settlement (RTGS)System

RTGS is a funds transfer systems where transfer of money takes place from one bank to
another on a "real time" and on "gross" basis. Settlement in "real time" means payment
transaction is not subjected to any waiting period. "Gross settlement" means the transaction is
settled on one-to-one basis without bunching or netting with any other transaction. Once
processed, payments are final and irrevocable. This was introduced in in 2004 and settles all
inter-bank payments and customer transactions above 2 lakh.

Clearing Corporation of India Limited (CCIL)

CCIL was set up in April 2001 by banks, financial institutions and primary dealers, to
function as an industry service organisation for clearing and settlement of trades in money
market, government securities and foreign exchange markets.

The Clearing Corporation plays the crucial role of a Central Counter Party (CCP) in the
government securities, USD –INR forex exchange (both spot and forward segments) and
Collaterised Borrowing and Lending Obligation (CBLO) markets. CCIL plays the role of a
central counterparty whereby, the contract between buyer and seller gets replaced by two new
contracts - between CCIL and each of the two parties. This process is known as ‘Novation’.
Through novation, the counterparty credit risk between the buyer and seller is eliminated with
CCIL subsuming all counterparty and credit risks. In order to minimize the these risks, that it
exposes itself to, CCIL follows specific risk management practices which are as per
international best practices.In addition to the guaranteed settlement, CCIL also provides non
guaranteed settlement services for National Financial Switch (Inter bank ATM transactions)
and for rupee derivatives such as Interest Rate Swaps.

CCIL is also providing a reporting platform and acts as a repository for Over the Counter
(OTC) products.
Other Payment Systems

Pre-paid Payment Systems

Pre-paid instruments are payment instruments that facilitate purchase of goods and services
against the value stored on these instruments. The value stored on such instruments represents
the value paid for by the holders by cash, by debit to a bank account, or by credit card. The
pre-paid payment instruments can be issued in the form of smart cards, magnetic stripe cards,
internet accounts, internet wallets, mobile accounts, mobile wallets, paper vouchers, etc.

Subsequent to the notification of the PSS Act, policy guidelines for issuance and operation of
prepaid instruments in India were issued in the public interest to regulate the issue of prepaid
payment instruments in the country.

The use of pre-paid payment instruments for cross border transactions has not been permitted,
except for the payment instruments approved under Foreign Exchange Management Act,1999
(FEMA).

Mobile Banking System

Mobile phones as a medium for providing banking services have been attaining increased
importance. Reserve Bank brought out a set of operating guidelines on mobile banking for
banks in October 2008, according to which only banks which are licensed and supervised in
India and have a physical presence in India are permitted to offer mobile banking after
obtaining necessary permission from Reserve Bank. The guidelines focus on systems for
security and inter-bank transfer arrangements through Reserve Bank's authorized systems. On
the technology front the objective is to enable the development of inter-operable standards so
as to facilitate funds transfer from one account to any other account in the same or any other
bank on a real time basis irrespective of the mobile network a customer has subscribed to.
ATMs / Point of Sale (POS) Terminals / Online Transactions

Presently, there are over 61,000 ATMs in India. Savings Bank customers can withdraw cash
from any bank terminal up to 5 times in a month without being charged for the same. To
address the customer service issues arising out of failed ATM transactions where the
customer's account gets debited without actual disbursal of cash, the Reserve Bank has
mandated re-crediting of such failed transactions within 12 working day and mandated
compensation for delays beyond the stipulated period. Furthermore, a standardised template
has been prescribed for displaying at all ATM locations to facilitate lodging of complaints by
customers.

There are over five lakh POS terminals in the country, which enable customers to make
payments for purchases of goods and services by means of credit/debit cards. To facilitate
customer convenience the Bank has also permitted cash withdrawal using debit cards issued
by the banks at PoS terminals.

The PoS for accepting card payments also include online payment gateways. This facility is
used for enabling online payments for goods and services. The online payment are enabled
through own payment gateways or third party service providers clled intermediaries. In
payment transactions involving intermediaries, these intermediaries act as the initial recipient
of payments and distribute the payment to merchants. In such transactions, the customers are
exposed to the uncertainty of payment as most merchants treat the payments as final on
receipt from the intermediaries. In this regard safeguard the interests of customers and to
ensure that the payments made by them using Electronic/Online Payment modes are duly
accounted for by intermediaries receiving such payments, directions were issued in
November 2009. Directions require that the funds received from customers for such
transactions need to be maintained in an internal account of a bank and the intermediary
should not have access to the same.
Further, to reduce the risks arising out of the use of credit/debit cards over internet/IVR
(technically referred to as card not present (CNP) transactions), Reserve Bank mandated that
all CNP transactions should be additionally authenticated based on information not available
on the card and an online alert should be sent to the cardholders for such transactions.

National Payments Corporation of India

The Reserve Bank encouraged the setting up of National Payments Corporation of India
(NPCI) to act as an umbrella organisation for operating various Retail Payment Systems
(RPS) in India. NPCI became functional in early 2009. NPCI has taken over National
Financial Switch (NFS) from Institute for Development and Research in Banking Technology
(IDRBT). NPCI is expected to bring greater efficiency by way of uniformity and
standardization in retail payments and expanding and extending the reach of both existing
and innovative payment products for greater customer convenience.

Oversight of Payment and Settlement Systems

Oversight of the payment and settlement systems is a central bank function whereby the
objectives of safety and efficiency are promoted by monitoring existing and planned systems,
assessing them against these objectives and, where necessary, inducing change. By
overseeing payment and settlement systems, central banks help to maintain systemic stability
and reduce systemic risk, and to maintain public confidence in payment and settlement
systems.

The Payment and Settlement Systems Act, 2007 and the Payment and Settlement Systems
Regulations, 2008 framed thereunder, provide the necessary statutory backing to the Reserve
Bank of India for undertaking the Oversight function over the payment and settlement
systems in the country.

Negotiable Instruments Act, 1881, Promissiory Notes, Bills of Exchange

and Cheques

Negotiable Instruments are written contracts whose benefit could be passed on from its
original holder to a new holder. In other words, negotiable instruments are documents which
promise payment to the assignee (the person whom it is assigned to/given to) or a specified
person. These instruments are transferable signed documents which promises to pay the
bearer/holder the sum of money when demanded or at any time in the future.

As mentioned above, these instruments are transferable. The final holder takes the funds and
can use them as per his requirements. That means, once an instrument is transferred, holder of
such instrument obtains a full legal title to such instrument.

Types of Negotiable Instruments

Promissory notes

A promissory note refers to a written promise to its holder by an entity or an individual to pay
a certain sum of money by a pre-decided date. In other words, Promissory notes show the
amount which someone owes to you or you owe to someone together with the interest rate
and also the date of payment.
For example, A purchases from B INR 10,000 worth of goods. In case A is not able to pay for
the purchases in cash, or doesn’t want to do so, he could give B a promissory note. It is A’s
promise to pay B either on a specified date or on demand.

In another possibility, A might have a promissory note which is issued by C. He could

endorse this note and give it to B and clear of his dues this way. However, the seller isn’t
bound to accept the promissory note. The reputation of a buyer is of great importance to a
seller in deciding whether to accept the promissory note or not

Bill of exchange

Bills of exchange refer to a legally binding, written document which instructs a party to pay a
predetermined sum of money to the second(another) party. Some of the bills might state that
money is due on a specified date in the future, or they might state that the payment is due on
demand.

A bill of exchange is used in transactions pertaining to goods as well as services. It is signed

by a party who owes money (called the payer) and given to a party entitled to receive money
(called the payee or seller), and thus, this could be used for fulfilling the contract for
payment. However, a seller could also endorse a bill of exchange and give it to someone else,
thus passing such payment to some other party.

It is to be noted that when the bill of exchange is issued by the financial institutions, it’s
usually referred to as a bank draft. And if it is issued by an individual, it is usually referred to
as a trade draft.

A bill of exchange primarily acts as a promissory note in the international trade; the exporter
or seller, in the transaction addresses a bill of exchange to an importer or buyer. A third party,
usually the banks, is a party to several bills of exchange acting as a guarantee for these
payments. It helps in reducing any risk which is part and parcel of any transaction.
Cheques

A cheque refers to an instrument in writing which contains an unconditional order, addressed

to a banker and is signed by a person who has deposited his money with the banker. This
order, requires the banker to pay a certain sum of money on demand only to the bearer of
cheque (person holding the cheque) or to any other person who is specifically to be paid as
per instructions given.

Cheques could be a good way of paying different kinds of bills. Although the usage of
cheques is declining over the years due to online banking.

Individuals still use cheques for paying for loans, college fees, car EMIs, etc.

Cheques are also a good way of keeping track of all the transactions on paper.

On the other side, cheques are comparatively a slow method of payment and might take some
time to be processed.

The Negotiable Instruments (Amendment) Bill, 2017

The Negotiable Instruments (Amendment) Bill, 2017 has been introduced in the Lok Sabha
earlier this year on Jan 2nd, 2018. The bill seeks for amending the existing Act. The bill
defines the promissory note, bill of exchange, and cheques. The bill also specifies the
penalties for dishonor of cheques and various other violations related to negotiable
instruments.

As per a recent circular, up to INR 10,000 along with interest at the rate of 6%-9% would
have to be paid by an individual for cheques being dishonored. The Bill also inserts a
provision for allowing the court to order for an interim compensation to people whose
cheques have bounced due to a dishonoring party (individuals/entities at fault). Such interim
compensation won’t exceed 20 percent of the total cheque value.

2.1 Introduction to Holder and Holder in Due Course

The concept and definition of a holder and a holder in due course have been discussed in
Section 8 and Section 9 of The Negotiable Instruments Act, 1881 respectively. Generally, the
holder of a negotiable instrument is the one who receives it by transfer.

The Negotiable Instruments Act, 1881 is a statute that regulates the working of instruments
on which amounts can be negotiated. It sets out the framework under which these instruments
operate and any violation in these rules has made been punished.

For the purpose of understanding the working of negotiable instruments, it is essential to

understand the complexities of the parties involved in a transaction that involves a negotiable
instrument.

Who is a holder under negotiable instruments act?

Meaning of Holder: – A holder is a person who legally obtains the negotiable instrument,
with his name entitled on it, to receive the payment from the parties liable. According to
section 8 of the Negotiable Instruments Act, 1881, a holder is a party who is entitled in his
own name and has legally obtained the possession of the negotiable instrument, i.e. bill, note
or cheque, from a party who transferred it, by delivery or endorsement, to recover the amount
from the parties liable to meet it.

The party transferring the negotiable instrument must be legally competent. It does not
include the person who finds the lost instrument payable to the carrier and the one who is in
wrongful possession of the negotiable instrument.

Kinds of Holder under negotiable instruments act

The following are the materials to be satisfied to be eligible to be a holder under negotiable
instruments act: –

De jure: – The holder of the Negotiable Instrument as a matter of legal right.

A person should have the right to have the instrument in his own name. It is not necessary
that the person has actual physical possession of the instrument. The principle is that a right
must be acquired under a legal title.
The name of the person should be in the instrument as payee or indorsee. He can also be the
bearer of the instrument if it is the bearer instrument. In cases where the holder dies, the heir
of such holder becomes the holder even when he is not the recipient or the insurer or the
holder of the instrument

De facto: – The holder of negotiable instrument by the virtue of possession but not entitled on
his own name.

Where any person comes to hold a negotiable instrument and does not have the right to hold
or keep it, he shall not be called a holder. A person who finds an instrument lying somewhere
or he stole the instrument, though may be in possession of such instrument, but he has no
right on that instrument. Therefore he cannot be called holders.

The person by means of the instrument shall be entitled to receive the amount which the
parties are liable to pay to the holder. So not only possession but also the right to receive the
amount is an important aspect to be called as a holder. After receiving the amount, the person
who is liable to pay the amount get relief from his/her liability.

In cases where a person finds the instrument lying somewhere or where any person has stolen
such equipment, he is not entitled to receive the amount. Thus he is not called a holder.

What are the rights of a Holder under negotiable instruments act?

Following are the rights of a Holder under negotiable instruments act: –

Section 8: – Holder has the legal right to possess the instrument and to recover and receive
the amount which due as per the instrument.

Section 14: – In Negotiation, a holder of a cheque has a right to negotiate to another person.
Moreover, in some cases, a holder has a power of negotiation even though cheque has no title
or faulty title.
Section 45A: – Holder has the right to get a duplicate of the instrument which is lost. In case
of misplacing of the cheque, the holder can ask to the drawer to give him another cheque of
the same tenor, but holder must give security to the drawer to indemnify him for all the loses
if the lost cheque has been found again.

Section 50: – Holder has the right to Indorse the instrument which basically means that
holder has the right to countersign the instrument. The holder of a cheque indorsed in blank
may convert the blank endorsement, by writing above the indorser’s signature which gives
direction to pay the cheque to or to the order of himself or any other person.

Section 61 and 64: – Holder has the right to present the instrument for acceptance if it is a bill
and receive payment if it is any other instrument. If a cheque is an open cheque then the
person can take it to the drawee bank and request payment in cash; but in case of crossed
cheques one cannot anticipate drawee bank to pay in cash, and he should, therefore, present it
to the drawee bank for payment.

Section 125: – In Crossings of cheque after issue; where the cheque is not crossed, the holder
may cross it generally or specially. Where the cheque is crossed generally, the holder may
cross it specially. He also the option of adding the words like “not negotiable” or “account
payee”.

Section 138: – In Notice of Dishonour of cheque, a cheque holder presents the cheque for
payment and if it does not get paid then he may give notice of dishonour outright to prior
parties in order to hold back their liability to him

Who is holder in due course under negotiable instruments act?

Meaning of holder in due course: – Holder in Due Course is defined as a person who acquires
the negotiable instrument in good faith for consideration before it becomes due for payment
and without any idea of a defective title of the party who transfers the instrument to him. A
person who acquires the negotiable instrument bonafide for some consideration, whose
payment is still due, is called holder in due course.
Section 9 of the Negotiable Instrument act, 1881, A holder in due course is a holder itself,
who accepts a negotiable instrument in a value-for-value exchange without doubting its
legitimacy so ultimately in a good faith. Now the person who took it for value in good faith
now becomes a real owner of the instrument and is known as “holder in due consideration”.
Every holder in due course is a holder but every holder in due course is not a holder.

If a negotiable instrument is acquired by a person for a price and he believes that there is no
defect in title whereby he took the instrument in good faith, then becomes the true owner of
the negotiable instrument and the holder in due course.

What are the essentials to be eligible to be a holder in due course?

The following are the materials to be satisfied to be eligible to be a holder in due course: –

 The person must hold the instrument for the valuable consideration;
 The person can become the holder of the instrument before its maturity;
 The negotiable instrument must be complete in all respects and requirements;
 The holder must have received the instrument in good faith.

If a person acquires a negotiable instrument after its maturity, he does not become a holder in
due course.

What are the rights of Holder in due course under negotiable instruments act?

Following are the rights of a Holder in due course under negotiable instruments act: –

Section 20: – The holder in due course gets a good title even though the instruments were
originally stamped but was an inchoate instrument. The person who has signed and delivered
an inchoate instrument cannot plead as against the holder in due course that the instrument
has not been filled in accordance with the authority given by him. However, a holder who
himself completes the instrument is not a holder in due course.

Section 36: – Every prior party to the instruments is liable to a holder in due course until the
instrument is duly satisfied.
Section 42: – Acceptor cannot plead against a holder in due course that the bill is drawn in a
fictitious name. In Bank of England vs. Vagliano Bros (1891 – Ac 107) it was held that the
acceptor should consider whether the bill was genuine or false before signing his acceptance
in it.

Sections 46 and Section 47: – The liable parties cannot deny liability to a holder who
negotiates a bill of exchange or promissory note on the ground that the delivery of the
instrument was subject to the conditions or had a specific purpose.

Section 53: – He gets a good title to the instrument even though the title of the transferor or
any price party to the instrument is defective. He can recover the full amount unless he was a
party to fraud; or if the instrument is negotiated by means of a forged endorsement.

Section 58: – The holder in due course has a superior title to the transferor of the instrument.
In cases where the transferor’s title was defective, the holder would get a good title in due
course. However, if the title is forged, the holder does not get the title in due course because
there is no defect in the title, but no title.

Even if the negotiable instrument is made without consideration, if it get into the hands of the
holder in due course, he can recover the amount on it from any of the prior parties thereto.

Section 118: – Every holder is deemed to be a holder in due course. Holder in due course can
file a suit in his own name against the parties liable to pay. He is deemed prima facie to be
holder in due course. The burden of proof is on the other party to show that the person is not
the holder in due course.

Section 120: – The validity of the instrument as originally made or dawn cannot be denied by
the maker of drawer of a negotiable instrument or by acceptor of a bill of exchange for honor
of the drawer

Section 121: – The maker of a promissory note, bill of exchange or a cheque shall not deny
the validity of the promissory note, bill of exchange or the capacity of the recipient on the
date of the bill of exchange, note, or cheque to endorse (countersign) the same. Therefore, a
holder is entitled to recover the amount mentioned in the instrument in due course even
though the payee has no capacity to indorse the instrument.
Section 122: – Endorser is not permitted as against the holder in due course to deny the
signature or capacity to contract of any prior party to the instrument.

Difference between holder and holder in due course

BASIS OF HOLDER HOLDER IN DUE COURSE

COMPARISON

Meaning A holder is a party who is A holder in due is a person

entitled in his own name and who get the possession of the
has legally received the negotiable instrument in a good
negotiable instrument, i.e., faith before it becomes due for
bill, note or cheque from a the payment and he has no idea
party who is liable to transfer of the defective title of the
it to recover the amount by person who transfers the
delivery or endorsement. instrument to him.

Section Section 8 of negotiable Section 9 of negotiable

instrument act,1881 instrument act,1881

Consideration In this consideration is not In this consideration is

necessary. necessary.

Right to sue Holder does not have the right Holder-in-due course can sue
to sue all prior parties. all the prior parties.

Good faith In this instrument may or may In this the instrument must be
not be in good faith. in good faith.

Maturity A person can become a holder A person can become a holder

before or after the maturity of in due course only before the
the negotiable instrument. maturity of the negotiable
instrument.

Short notes for 2.1

Definitions of Transferability & Negotiability : Transferability-

Transferability is a characteristic of any property, which gives right to the possessor of the
property to transfer it to anyone with or without consideration, provided he can establish that
he is a true owner and in that capacity he has exercised his right of transfer. Negotiability- It
is also a characteristic of any property. It also gives a right to the possessor of the property to
transfer it to anyone but for consideration. Here the negotiator is not required to establish his
credentials. In negotiability, the property is accepted in good faith. Differences between
Transferability & Negotiability :

1. Transferability is the part of negotiability, negotiation without transfer either by simple

delivery or by endorsement stand meaningless. Transferability is complete in itself. It is only
exchange of hands, which is an act and which needs performances.

2. Negotiation is an expression of faith and confidence. Transfer, on the other hand, is a

process.

3. In negotiation, even if the owner is not having a good title, it doesn't affect the rights and
title of the negotiation. Transfer is exchange of hands. Here possession is delivered.
Transferability rights need a lawful and unchallengeable title.

4. 'Not Negotiable' marked documents lose all essential features of negotiability. 'Non
Transferable' marked documents can also be transferred to the person whose name is
mentioned therein.

HOLDER & HOLDER IN DUE COURSE -

"Holder of a promissory note, bill of exchange or 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."(Sec.8, N.I. Act,1881). "Holder in

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

(HOLDER, Sec.8 & HOLDER IN DUE COURSE, Sec.9,N.I.Act).

A person becomes the holder in due course of a negotiable instrument, if the following
conditions are satisfied:

i) The Negotiable Instrument should be in the possession of the holder in due course.
ii) The Negotiable Instrument should be regular and complete in all respects.
iii) The Negotiable Instrument should have been obtained for valuable consideration,
i.e., by paying its full value.
iv) The Negotiable Instrument should have been obtained before the amount
mentioned therein becomes payable.
v) The holder in due course should obtain the Negotiable Instrument without having
sufficient cause to believe that any defect existed in the title of transferor.

NI Act

4. “Promissory note.”—A “Promissory note” is an instrument in writing (not being a bank-

note or a 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.

Illustrations

A Signs instruments in the following terms:

(a ) “I promise to pay B or order Rs. 500.”

(b) “I acknowledge myself to be indebted to B in Rs. 1,000, to be paid on demand, for value
received.”

(c) “Mr. B, I O U Rs. 1,000.”

(d) “I promise to Pay B Rs. 500 and all other sums which shall be due to him.”

(e) “I promise to Pay B Rs. 500, first deducting thereout any money which he may owe me.”
(f) “I promise to Pay B Rs. 500 seven days after my marriage with C.”

(g) “I, promise to Pay B Rs. 500 on D's death, provided D leaves me enough to pay that
sum.”

(h) “I promise to Pay B Rs. 500 and to deliver to him my black horse on 1st January next.”

The instruments respectively marked (a) and (b) are promissory notes. The instruments
respectively marked (c),(d), (e), (f), (g) and (h) are not promissory notes.

5. “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.

A promise or order to pay is not “conditional”, within the meaning of this section and section
4, by reason of the time for payment of the amount or any instalment thereof being expressed
to be on the lapse of a certain period after the occurrence of a specified even which,
according to the ordinary expectation of mankind, is certain to happen, although the time of
its happening may be uncertain.

The sum payble may be “certain”, within the meaning of this section and section 4, although
it includes future interest or is payable at an indicated rate of exchange, or is according to the
course of exchange, and although the instrument provides that, on default of payment of an
instalment, the balance unpaid shall become due.

The person to whom it is clear that the direction is given or that payment is to be made may
be a “certain person”, within the meaning of this section and section 4, although he is mis-
named or designated by description only.

[6. “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
truncated cheque and a cheque in the electronic form.
Explanation I.—For the purposes of this section, the expressions—

2[(a) “a cheque in the electronic form” means a cheque drawn in electronic form by using any
computer resource and signed in a secure system with digital signature (with or without
biometrics signature) and asymmetric crypto system or with electronic signature, as the case
may be;]

(b) “a truncated cheque” means a cheque which is truncated during the course of a clearing
cycle, either by the clearing house or by the bank whether paying or receiving payment,
immediately on generation of an electronic image for transmission, substituting the further
physical movement of the cheque in writing.

Explanation II.— For the purposes of this section, the expression “clearing house” means the
clearing house managed by the Reserve Bank of India or a clearing house recognised as such
by the Reserve Bank of India.]

3[Explanation III.—For the purposes of this section, the expressions “asymmetric crypto
system”, “computer resource”, “digital signature”, “electronic form” and “electronic
signature” shall have the same meanings respectively assigned to them in the Information
Technology Act, 2000 (21 of 2000).

9. “Holder in due course”.—“Holder in due course” 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 indorsee thereof, if 1[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.

118. Presumptions as to negotiable instruments.—Until the contrary is proved, the following

presumptions shall be made:—

(a) of consideration:—that every negotiable instrument was made or drawn for consideration,
and that every such instrument, when it has been accepted, indorsed, negotiated or
transferred, was accepted, indorsed, negotiated or transferred for consideration;
(b) as to date:—that every negotiable instrument bearing a date was made or drawn on such
date; (c) as to time of acceptance:—that every accepted bill of exchange was accepted within
a

reasonable time after its date and before its maturity;

(d) as to time of transfer:—that every transfer of a negotiable instrument was made before its
maturity;

(e) as to order of indorsements: —that the indorsements appearing upon a negotiable

instrument were made in the order in which they appear then on;

(f) as to stamp: — that a lost promissory note, bill of exchange or cheque was duly stamped.

(g) that holder is a holder in due course:— that the holder of a negotiable instrument is a
holder in due course : provided that, where the instrutment has been obtained from its lawful
owner, or from any person in lawful custody thereof, by means of an offence or fraud, or has
been obtained from the maker or acceptor thereof by means of an offence or fraud, or for
unlawful consideration, the burden of proving that the holder is a holder in due course lies
upon him.

Unit.3 Understanding Cheques

Relevant Sections under NI Act, 1881

S. 123. Cheque crossed generally. —Where a cheque bears across its face an addition of
the words “and company” or any abbreviation thereof, between two parallel transverse lines,
or of two parallel transverse lines simply, either with or without the words “not negotiable”,
that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed
generally.

S. 124. Cheque crossed specially. —Where a cheque bears across its face an addition of the
name of a banker, either with or without the words “not negotiable”, that addition shall be
deemed a crossing and the cheque shall be deemed to be crossed specially, and to be crossed
to that banker.

130. Cheque bearing “not negotiable”. —A person taking a cheque crossed generally or
specially, bearing in either case the words “not negotiable”, shall not have, and shall not be
capable of giving, a better title to the cheque than that which the person from whom he took it
had.

A cheque is a negotiable instrument. It can either be open or crossed. An open cheque is the
bearer cheque. It is payable over the counter on presentment by the payee to the paying
banker. While a crossed cheque is not payable over the counter but shall be collected only
through a banker. The amount payable for the crossed cheque is transferred to the bank
account of the payee. Types of cheque crossing are General Crossing, Special Crossing and
Restrictive Crossing.

Crossing a Cheque

A crossing is an instruction to the paying banker to pay the amount of cheque to a particular
banker and not over the counter. The crossing of the cheque secures the payment to a banker.

It also traces the person so receiving the amount of cheque. Addition of words ‘Not
negotiable’ or ‘Account Payee only’ is necessary to restrain the negotiability of the cheque.
The crossing of a cheque ensures security and protection to the holder.
However, we can negotiate a crossed bearer cheque by delivery and a crossed order cheque
by endorsement and delivery.

Types of Cheque Crossing (Sections 123-131 A):

General Crossing – cheque bears across its face an addition of two parallel transverse lines.

Special Crossing – cheque bears across its face an addition of the banker’s name.

Restrictive Crossing – It directs the collecting banker that he needs to credit the amount of
cheque only to the account of the payee.

Non-Negotiable Crossing – It is when the words ‘Not Negotiable’ are written between the
two parallel transverse lines.

General Cheque Crossing

In general crossing, the cheque bears across its face an addition of two parallel transverse
lines and/or the addition of words ‘and Co.’ or ‘not negotiable’ between them.

In the case of general crossing on the cheque, the paying banker will pay money to any
banker. For the purpose of general crossing two transverse parallel lines at the corner of the
cheque are necessary.Thus, in this case, the holder of the cheque or the payee will receive the
payment only through a bank account and not over the counter. The words ‘and Co.’ have no
significance as such.

But, the words ‘not negotiable’ are significant as they restrict the negotiability and thus, in
the case of transfer, the transferee will not give a title better than that of a transferor.

Special Cheque Crossing

In special crossing, the cheque bears across its face an addition of the banker’s name, with or
without the words ‘not negotiable’.In this case, the paying banker will pay the amount of
cheque only to the banker whose name appears in the crossing or to his collecting agent.

Thus, the paying banker will honor the cheque only when it is ordered through the bank
mentioned in the crossing or its agent bank.However, in special crossing two parallel
transverse lines are not essential but the name of the banker is most important.

Restrictive Cheque Crossing or Account Payee’s Crossing

This type of crossing restricts the negotiability of the cheque. It directs the collecting banker
that he needs to credit the amount of cheque only to the account of the payee, or the party
named or his agent. Where the collecting banker credits the proceeds of a cheque bearing
such crossing to any other account, he shall be guilty of negligence. Also, he will not be
eligible for the protection to the collecting banker under section 131 of the Act.

However, such crossing will have no effect on the paying banker. This is so because it is not
his duty to determine that the cheque is collected for the account of the payee.

Not Negotiable Cheque Crossing

It is when the words ‘Not Negotiable’ are written between the two parallel transverse lines
across the face of the cheque in the case of general crossing or in the case of special crossing
along with the name of a banker.

The Not Negotiable Crossing does not mean that the cheque is non-transferrable. As per
section 130 of the Negotiable Instruments Act, 1881 a person taking a cheque bearing a
general or special crossing with the words ‘not negotiable’ will not have and is neither
capable of giving a better title than that which the person from whom he took it had.
One of the important features of a negotiable instrument is that a person who receives it in
good faith, without negligence, for value, before maturity and without knowing the defect in
the title of the transferor, gets a good title to the instrument.

Thus, he becomes the holder in due course and acquires an indisputable title to it. Also, when
the instrument passes through a holder in due course, all the subsequent holders also receive a
good title. But, Not Negotiable Crossing takes away this important feature. In this case, the
transferee does not get the rights of the holder in due course.

Only if the title of the transferor is good, the title of the transferee is also good. Hence, in case
of any taint in the title of any one of the endorsers, the title of all the subsequent transferees
also becomes tainted.

Dishonur of cheque and legal procedure

Relevant Sections under NI Act, 1881

S. 138. Dishonour of cheque for insufficiency, etc., of funds in the account.—Where any
cheque drawn by a person on an account maintained by him with a banker for payment of any
amount of money to another person from out of that account for the discharge, in whole or in
part, of any debt or other liability, is returned by the bank unpaid, either because of the
amount of money standing to the credit of that account is insufficient to honor the cheque or
that it exceeds the amount arranged to be paid from that account by an agreement made with
that bank, such person shall be deemed to have committed an offence and shall, without
prejudice to any other provision of this Act, be punished with imprisonment for 8[a term
which may be extended to two years’], or with fine which may extend to twice the amount of
the cheque, or with both:

Provided that nothing contained in this section shall apply unless—

(a) the cheque has been presented to the bank within a period of six months from the date on
which it is drawn or within the period of its validity, whichever is earlier;

(b) the payee or the holder in due course of the cheque, as the case may be, makes a demand
for the payment of the said amount of money by giving a notice; in writing, to the drawer of
the cheque, 9[within thirty days] of the receipt of information by him from the bank regarding
the return of the cheque as unpaid; and

(c) the drawer of such cheque fails to make the payment of the said amount of money to the
payee or, as the case may be, to the holder in due course of the cheque, within fifteen days of
the receipt of the said notice.

Explanation.—For the purposes of this section, “debt of other liability” means a legally
enforceable debt or other liability.

S. 142. Cognizance of offences. —2[(1)] Notwithstanding anything contained in the Code of

Criminal Procedure, 1973 (2 of 1974),—

(a) no court shall take cognizance of any offence punishable under section 138 except upon a
complaint, in writing, made by the payee or, as the case may be, the holder in due course of
the cheque;
(b) such complaint is made within one month of the date on which the cause of action arises
under clause (c) of the proviso to section 138:

3[Provided that the cognizance of a complaint may be taken by the Court after the prescribed
period, if the complainant satisfies the Court that he had sufficient cause for not making a
complaint within such period;]

(c) no court inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the first
class shall try any offence punishable under section 138.].

4[(2) The offence under section 138 shall be inquired into and tried only by a court within
whose local jurisdiction,—

(a) if the cheque is delivered for collection through an account, the branch of the bank where
the payee or holder in due course, as the case may be, maintains the account, is situated; or

(b) if the cheque is presented for payment by the payee or holder in due course, otherwise
through an account, the branch of the drawee bank where the drawer maintains the account, is
situated.

Explanation.—For the purposes of clause (a), where a cheque is delivered for collection at
any branch of the bank of the payee or holder in due course, then, the cheque shall be deemed
to have been delivered to the branch of the bank in which the payee or holder in due course,
as the case may be, maintains the account.]

Cheques are used in almost all transactions such as re-payment of loan, payment of salary,
bills, fees, etc. A vast majority of cheques are processed and cleared by banks on daily basis.
Cheques are issued for the reason of securing proof of payment. Nevertheless, cheques
remain a reliable method of payment for many people. On the other hand, it is always
advisable to issue crossed “Account Payee Only” cheques in order to avoid its misuse.

A cheque is a negotiable instrument. Crossed and account payee cheques are not negotiable
by any person other than the payee. The cheques have to be deposited into the payee's bank
account.

Legally, the author of the cheque is called ‘drawer’, the person in whose favour, the cheque is
drawn is called ‘payee’, and the bank who is directed to pay the amount is known as
‘drawee’.

However, cases of cheque bounce are common these days. Sometimes cheques bearing large
amounts remain unpaid and are returned by the bank on which they are drawn.

The below article provides information on what you may do if your cheque is dishonoured?
Here’s a step-by-step guide to the legal procedure that is available to you.

If a cheque is dishonoured

When a cheque is dishonoured, the drawee bank immediately issues a ‘Cheque Return
Memo’ to the banker of the payee mentioning the reason for non-payment. The payee’s
banker then gives the dishonoured cheque and the memo to the payee. The holder or payee
can resubmit the cheque within three months of the date on it, if he believes it will be
honoured the second time. However, if the cheque issuer fails to make a payment, then the
payee has the right to prosecute the drawer legally.

The payee may legally sue the defaulter / drawer for dishonour of cheque only if the amount
mentioned in the cheque is towards discharge of a debt or any other liability of the defaulter
towards payee.

If the cheque was issued as a gift, towards lending a loan or for unlawful purposes, then the
drawer cannot be prosecuted in such cases.

Legal action
The Negotiable Instruments Act, 1881 is applicable for the cases of dishonour of cheque.
This Act has been amended many times since 1881.According to Section 138 of the Act, the
dishonour of cheque is a criminal offence and is punishable by imprisonment up to two years
or with monetary penalty or with both. If payee decides to proceed legally, then the drawer
should be given a chance of repaying the cheque amount immediately. Such a chance has to
be given only in the form of notice in writing.

The payee has to sent the notice to the drawer with 30 days from the date of receiving
“Cheque Return Memo” from the bank. The notice should mention that the cheque amount
has to be paid to the payee within 15 days from the date of receipt of the notice by the
drawer. If the cheque issuer fails to make a fresh payment within 30 days of receiving the
notice, the payee has the right to file a criminal complaint under Section 138 of the
Negotiable Instruments Act.

However, the complaint should be registered in a magistrate’s court within a month of the
expiry of the notice period. It is essential in this case to consult an advocate who is well
versed and experienced in this area of practice to proceed further in the matter.

Fine points: Conditions for prosecution

Legally, certain conditions have to be fulfilled in order to use the provisions of Section 138.

1. The cheque should have been drawn by the drawer on an account maintained by him.
2. The cheque should have been returned or dishonoured because of insufficient funds in
the drawer's account.
3. The cheque is issued towards discharge of a debt or legal liability.
4. After receiving the notice, if the drawer doesn't make the payment within 30 days
from the day of receiving the notice, then he commits an offence punishable under
Section 138 of the Negotiable Instruments Act.

Punishment & penalty

On receiving the complaint, along with an affidavit and relevant paper trail, the court will
issue summons and hear the matter. If found guilty, the defaulter can be punished with
monetary penalty which may be twice the amount of the cheque or imprisonment for a term
which may be extended to two years or both. The bank also has the right to stop the cheque
book facility and close the account for repeat offences of bounced cheques.

If the drawer makes payment of the cheque amount within 15 days from the date of receipt of
the notice, then drawer does not commit any offence. Otherwise, the payee may proceed to
file a complaint in the court of the jurisdictional magistrate within one month from the date of
expiry of 15 days prescribed in the notice.

Reasons for Dishonour of Cheque

· Insufficient Funds

· Signature not matching

· Account Closed

· Cheque was presented after three months

· Payment stopped by account holder

· Disparity in the words and figures mentioned in the cheque

· In case of a joint account where both signatures are required but only one is there

· Death of the customer

· Insanity of the customer

· Crossing limit of the overdraft

New Cheque Bounce Rule:

According to a notice issued by the Reserve Bank of India (RBI) in early August of 2021,
customers whose financial activities revolve heavily around cheques or those who even plan
to use cheques will have to ensure a minimum bank balance. If this minimum balance is not
maintained, the cheque will bounce. In addition to this, the customer who issued the cheque
may also have to pay a penalty fee. Along with these changes, the RBI announced that the
National Automated Clearing House (NACH) would be operational 24 hours a day.
These changes apply to all national and private banks. The rule change was brought in to
make clearing the cheques a faster and generally smoother one. Since the new rule ensures
that NACH will be operational on all days of the week, Sundays will also be a day on which
the entity can process and clear a cheque.

Landmark Cases:

Name of the case – Modi Cements Ltd vs. Shri Kuchil Kumar Nandi, (1998) 3 SCC 249
(Supreme Court)

Date of Judgment – 02nd March 1998

Judges: Justice M.K. Mukherjee, Justice S.P. Kurdukar and Justice K.T. Thomas

Subject and sections involved – Section 138 of Negotiable Instruments Act, 1881

Issue:

Whether mere endorsement of the Bank “payment stopped” is sufficient to entertain the
complaint u/s 138 of NI Act?

Fact of the Case:

Appellant, Modi Cements Ltd, is a company known for selling cement throughout India. It
was alleged by appellant that respondent, Kuchil Nandi, purchased from them non-levy Modi
Cement on credit against the orders placed on behalf of his concerns. These orders were
placed by the respondent with the Calcutta office of the appellant and it was agreed that the
price of the consignments was to be paid by the respondent at the said office. After taking
accounts it was found that on 23.2.1994 the respondent incurred a liability/debt of Rs.
1,10,53,520.30 payable to the appellant towards the purchased price of the cement supplied
by them to the respondent. In partial discharge of the said liability/debt the respondent drew
three cheques in favour of the appellant.

Ratio of the Case:

The three-judge bench of Supreme Court held that even “stop payment” instruction would
attract the mischief of section 138. It was observed that if after the cheque is issued to the
payee or to the holder in due course and before it is presented for encashment, notice is issued
to him not to present the same for encashment and yet the payee or holder in due course
present the cheque to the bank for payment and when it is returned on instruction, Section
138 of NI Act does not get attracted.

Object of the Act

The object of Sections 138-142 of the Negotiable Instruments Act, 1881 is to promote the
efficacy of banking operations and to ensure credibility in transacting business through
cheques.

Section 138 of the Act is a penal provision wherein if a person draws a cheque on an account
maintained by him with the Banker for payment of any amount of money to another person
from out of that account for the discharge, in whole or in part of any debt or other liability, is
returned by the Bank unpaid, on the ground either because of the amount of money standing
to the credit of that account is insufficient to honor the cheque or that it exceeds the amount
arranged to be paid from that account by an agreement made with that bank, such person
shall be deemed to have committed an offence. The distinction between the deeming
provision and the presumption is well discernible. To illustrate, if a person, draws a cheque
with no sufficient funds available to his credit on the date of issue, but makes the
arrangement or deposited the amount thereafter before the cheque is out in the bank by the
drawer, and the cheque is honored, in such a situation drawing of presumption of dishonesty
on the part of the drawer under Section 138 would not be justified. Section 138 of the Act
gets attracted only when the cheque is dishonored. (20) On careful reading of Section 138 of
the Act, we are unable to subscribe to the view that Section 138 of the Act draws presumption
of dishonesty against drawer of the cheque if he without sufficient funds to his credit in his
bank account to honor the cheque issues the same and, therefore, amounts to an offence under
Section 138 of the Act. For the persons stated hereinabove, we are unable to share the views
expressed by this Court in the above two cases and we respectfully differ with the same
regarding interpretation of Section 138 of the Act of the limited extent as indicated above.

Sampelly Satyanarayana Rao v. Indian Renewable Energy Development Agency

Limited

On September 19, 2016, the SC in Sampelly Satyanarayana Rao v. Indian Renewable Energy
Development Agency Limited dealt with the issue of whether the dishonor of post-dated
cheques that have been described as ‘security’ in a loan agreement, would attract criminal
liability under Section 138 of the Negotiable Instruments Act, 1881 (‘Negotiable Instruments
Act’), the penalty for which includes imprisonment for a term upto two years, or a fine, or
both. The SC held that Section 138 of the Negotiable Instruments Act applies only if, on the
date of issuance of the cheque, the liability or debt exists or the amount has become legally
recoverable, and not otherwise. The SC further held that the issuance of a cheque and
admitted signature on such cheque creates a presumption of a legally enforceable debt in
favour of the payee, and a mere statement by the accused that the cheques were issued as
“security” and not as repayment, would not rebut this presumption. In the present case,
though the word “security” was used, the cheques were towards repayment of installments,
which became due under the relevant agreement immediately upon advancement of the loan.
Therefore, the dishonor of cheque was for an existing liability and covered under Section 138
of the Negotiable Instruments Act.

Calling in question the decision of 2-judge bench in K. Bhaskaran v. Sankaran Vaidhyan

Balan, (1999) 7 SCC 510, famously known as the Bhaskaran Case on the issue of Territorial
Jurisdiction of trial for the Complaint made for dishonor of cheque, the 3-judge bench of T.S.
Thakur, Vikramjit Sen and C. Nagappan, JJ held that the liberal approach preferred in
Bhaskaran case calls for a stricter interpretation of Section 138 of the Negotiable Instruments
Act, 1881 (NIA) precisely because of its misemployment so far as choice of place of suing is
concerned. The Court, Bhaskaran Case, had held that the jurisdiction to try an offence under
Section 138 NIA could not be determined only by reference to the place where the cheque
was dishonoured as the dishonour of the cheque was not by itself an offence under Section
138 NIA and that the offence was completed only when the drawer failed to pay the cheque
amount within the period of fifteen days stipulated under clause (c) of the proviso to Section
138 of the Act and held that any court within whose jurisdiction any of the above acts were
committed had jurisdiction.

Accepting the judgment of 2-judge bench in Harman Electronics Pvt. Ltd. v. National
Panasonic India Pvt. Ltd. (2009) 1 SCC 720(Harman), where it was held that what would
constitute an offence is stated in the main provision of Section 138 NIA and the proviso
appended thereto, imposes certain further conditions which are required to be fulfilled before
cognizance of the offence can be taken, the Court held that in criminal jurisprudence there is
a discernibly demarcated difference between the commission of an offence and its cognizance
leading to prosecution. It was held that the Harman approach is significant and sounds a
discordant note to the Bhaskaran ratio.

In the present case in which Anagha Desai and CS Ashri represented the appellant and
respondents, respectively, considering the various judgments of the Supreme Court, the Court
overruled the Bhaskaran Ratio and, considering that Section 177 CrPC applies to Section 138
NIA, held that prosecution can be launched only before the Court within whose jurisdiction
the dishonour takes place except in situations where such offence is committed along with
other offences in a single transaction within the meaning of Section 220(1); read with Section
184 CrPC or is covered by the provisions of Section 182(1); read with Sections 184 and 220
CrPC thereof. Dashrath Rupsingh Rathod v. State of Maharashtra, Criminal Appeal No. 2287
of 2009, decided on 01.08.2014

Dishonor of a Cheque and approach of Hon. Apex Court on Territorial Jurisdiction of the
Court. :

Previously, if a cheque gets dishonored then the Payee after performing legal formalities had
option of filing the Complaint in any of the court amongst five options and this principle was
being followed in the law field over a period of 15 years. Thanks to the Judgment delivered
by Hon. Apex Court in the case of K. Bhaskaran V/s. Sankaran Vaidhyan Balan , wherein
two Judges Bench was pleased to hold that, the Offense under Sec.138 of the Negotiable
Instruments Act, (the Act) can be completed only with the concatenation of a number of acts
and which includes following components.

1) Drawing of the Cheque.

2) Presentation of the Cheque to the Bank.

3) Returning the Cheque unpaid by the Drawee Bank,

4) Giving notice in Writing to the Drawer of the cheque demanding payment of the cheque
amount and

5) Failure of the Drawer of the Cheque to make payment within 15 days (now 30 days) of the
receipt of the notice. It was further held that mere giving or receipt of the notice does not
make the offense, but failure to make the payment within stipulated period of 15 days (now
30 days) makes the offense on the 16th day (now 31st day). The above referred five
components could happen in 5 different places e.g. A business man carrying his business in
Pune gives a cheque to B who carries business in Surat and when the Cheque is Dishonored,
B issues notice to A through his Advocate having office in Mumbai. In this case B had option
of filing case in Pune, Surat and Mumbai.
However, this principle has been overruled by the recent 3 Judges Bench Judgment of Hon
apex Court in the Judgment delivered in the case of Dashrath Rathod & ors. V/s. State of
Maharashtra & ors. The Hon. Apex court observed that the judgment of K. Bhaskarans case
(Supra) was widely abused and misused.

Unit. 5 Legal Aspects of Banking Operations

Relevant Sections under ICA

126. “Contract of guarantee”, “surety”, “principal debtor” and “creditor”. —A

“contract of guarantee” is a contract to perform the promise, or discharge the liability, of a
third person in case of his default. The person who gives the guarantee is called the “surety”;
the person in respect of whose default the guarantee is given is called the “principal debtor”,
and the person to whom the guarantee is given is called the “creditor”. A guarantee may be
either oral or written.

171. General lien of bankers, factors, wharfingers, attorneys and policy-brokers.—

Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers may, in the
absence of a contract to the contrary, retain as a security for a general balance of account, any
goods bailed to them; but no other persons have a right to retain, as a security for such
balance, goods bailed to them, unless there is an express contract to that effect.

174. Pawnee not to retain for debt or promise other than that for which goods pledged.
Presumption in case of subsequent advances. —The pawnee shall not, in the absence of a
contract to that effect, retain the goods pledged for any debt or promise other than the debt or
promise for which they are pledged; but such contract, in the absence of anything to the
contrary, shall be presumed in regard to subsequent advances made by the pawnee.

Rights and Duties of Banker and Customer

It is very difficult to live without a bank account as it is required for many things. As more
than 50% of Indians have bank accounts, it is very important for you to know the rights and
duties of both bankers and customers. In this blog, we will discuss the rights and duties of
bankers and customers.
Rights of a Banker

1. Right to charge interest

Every bank in India has the right to charge interest on the loans and advances sanctioned to
customers. Interest is usually charged monthly, quarterly, semiannually or annually.

2. Right to levy commission and service charges

Along with interest, banks also have the right to levy a commission and service charges for
the services rendered. The service rendered by the bank might be SMS notification service,
retail banking and so on. Banks can also debit these charges from the customer's bank
account.

3. Right of Lien

Another important right enjoyed by banks is the Right of Lien. Banks have the right to keep
goods and securities belonging to the debtor as a security, until the loan is repaid by the
debtor. Banks have only the right to maintain the security of the debtor and not to sell.

4. The Right of Set-off

The banker has the right to set off customer accounts. Banks can merge a couple of accounts
which are in the name of the customer and set off the debit balance in one account with the
credit balance in the other, provided the funds belong to the customer.

5. Right of Appropriation

Let us consider that a customer has taken many loans from the bank and he deposits some
money in the bank without any instructions. If that amount is not sufficient to discharge all
loans, the bank has the right to appropriate the amount deposited to any loan, even to a time-
barred debt. But the customer should be informed on the same.

6. Right to Close the Account

If the customer’s account is not properly maintained, banks have all the right to close the
account by sending a notice to the customer. Bankers have no right to close the account,
without sending a written notice.

Rights of a Customer

1. Right to fair treatment

According to this right, banks cannot discriminate between customers on the basis of gender,
age, religion, caste, and physical ability while providing services. This does not mean that
banks cannot offer schemes which are designed for a particular set of people. Banks have all
the right to offers differential rates of interest or products to customers.

2. Right of transparent, fair and honest dealing

The contract between the banks and customers should be easily understood by the common
man. It is the responsibility of the bank to make the customer understand interest rates, the
risk involved and all other terms and conditions. Banks should not hide anything from the
customer before the signing of the agreement. Even if there are any short comings, they
should be communicated to the customer. The language in the contract should be simple and
easily understood.

3. Right to suitability

You might have come across a lot of cases of mis-selling of financial products, especially life
insurance policies. Usually, customers are forced to buy the product which offers the highest
commission to an agent. As per this right, customers should be sold the product which is
suitable to them. So, banks should always keep customers needs in mind, before selling any
product.
4. Right to privacy

As per this law, the personal information provided by the customers to the bank, must be kept
confidential. Bankers can disclose only such information, which is required by law or only
after customers have given permission. Banks are not allowed to provide your details to
telemarketing companies or for cross-selling.

5. Right to grievance redressal and compensation

Banks are responsible for all the products and services offered by them and customers have
the right to easy and simple grievance redressal systems in case the bank fails to adhere to
basic norms. Along with their own products, bankers are responsible for the products of third
parties like insurance companies and fund houses. If the customer complaint is not resolved
by the bank, customers can go to the banking ombudsman.

Duties of customers to banks

1. It is the duty of customers to present the cheque and other negotiable instruments only
during the business hours of the bank.

2. In the case of any disagreement in the bank statement, customers should inform the bank.

3. Whenever photographs of customers are required by the bank, it should be submitted.

4. It is the duty of the customer to present the instrument of credit within the due time from
the date of issue.

5. The cheque should be filled by customers very carefully.

6. If the cheque book is lost or stolen, it is the duty of the customers to inform the bank.

7. If the customer notices any forgery in the amount of the cheque, he/she should inform it to
the bank immediately.

8. Customers should provide proper information in the Know Your Customer (KYC) form.
9. Customers should make the repayment of all the dues on time.

10. It is the duty of the customers to read the MITC ( Most Important Terms and Conditions)

Obligations of Bankers

1. It is the duty of the bank to honor the cheques of its customers up to the amount standing to
the credit of the customer’s account. The bank is liable to pay the compensation to the
customer, if it wrongfully refuses to honor the cheque.

2. It is the duty of the bank to follow the instructions given by the customers. If the customer
has not given any instructions, the bank should act as per rules and regulations.

3. Bankers should not disclose personal information given by customers to any outsider.

4. Banks should maintain all details of transactions made by the customer.

What Is a Letter of Credit?

A letter of credit, or "credit letter," is a letter from a bank guaranteeing that a buyer's payment
to a seller will be received on time and for the correct amount. In the event that the buyer is
unable to make a payment on the purchase, the bank will be required to cover the full or
remaining amount of the purchase. It may be offered as a facility.

Due to the nature of international dealings, including factors such as distance, differing laws
in each country, and difficulty in knowing each party personally, the use of letters of credit
has become a very important aspect of international trade.

How a Letter of Credit Works

Because a letter of credit is typically a negotiable instrument, the issuing bank pays the
beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferable, the
beneficiary may assign another entity, such as a corporate parent or a third party, the right to
draw.

Banks typically require a pledge of securities or cash as collateral for issuing a letter of
credit.

Banks also collect a fee for service, typically a percentage of the size of the letter of credit.
The International Chamber of Commerce Uniform Customs and Practice for Documentary
Credits oversees letters of credit used in international transactions.1 There are several types
of letters of credit available.

Types of Letters of Credit

Commercial Letter of Credit

This is a direct payment method in which the issuing bank makes the payments to the
beneficiary. In contrast, a standby letter of credit is a secondary payment method in which the
bank pays the beneficiary only when the holder cannot.

Revolving Letter of Credit

This kind of letter allows a customer to make any number of draws within a certain limit
during a specific time period.

Traveler's Letter of Credit

For those going abroad, this letter will guarantee that issuing banks will honor drafts made at
certain foreign banks.

Confirmed Letter of Credit

A confirmed letter of credit involves a bank other than the issuing bank guaranteeing the
letter of credit. The second bank is the confirming bank, typically the seller’s bank. The
confirming bank ensures payment under the letter of credit if the holder and the issuing bank
default. The issuing bank in international transactions typically requests this arrangement.

Real-Life Example of a Letter of Credit

Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia,
and the Middle East who may have difficulty obtaining international credit on their own.
Citibank’s letters of credit help exporters minimize the importer’s country risk and the
issuing bank’s commercial credit risk.

Letters of credit are typically provided within two business days, guaranteeing payment by
the confirming Citibank branch. This benefit is especially valuable when a client is located in
a potentially unstable economic environment.

How Does a Letter of Credit Work?

Often in international trade, a letter of credit is used to signify that a payment will be made to
the seller on time, and in full, as guaranteed by a bank or financial institution. After sending a
letter of credit, the bank will charge a fee, typically a percentage of the letter of credit, in
addition to requiring collateral from the buyer. Among the various forms of letters of credit
are a revolving letter of credit, a commercial letter of credit, and a confirmed letter of credit.

What Is an Example of a Letter of Credit?

Consider an exporter in an unstable economic climate, where credit may be more difficult to
obtain. The Bank of America would offer this buyer a letter of credit, available within two
business days, in which the purchase would be guaranteed by a Bank of America branch.
Because the bank and the exporter have an existing relationship, the bank is knowledgeable
of the buyer's creditworthiness, assets, and financial status.

What Is the Difference Between a Commercial Letter of Credit and a Revolving Letter of
Credit?

As one of the most common forms of letters of credit, commercial letters of credit are when
the bank makes payment directly to the beneficiary or seller. Revolving letters of credit, by
contrast, can be used for multiple payments within a specific time frame. Typically, these are
used for businesses that have an ongoing relationship, with the time limit of the arrangement
usually spanning one year.

KEY TAKEAWAYS

A letter of credit is a document sent from a bank or financial institute that guarantees that a
seller will receive a buyer's payment on time and for the full amount.

Letters of credit are often used within the international trade industry.

There are many different letters of credit including one called a revolving letter of credit.

Banks collect a fee for issuing a letter of credit.

Bankers Lien

Lien is a right of possession of property or goods by a person who is due for payment of any
kind. It is a right under law instead of a contract under the Indian Contract Act. A key
component for holding the possession of property or goods is that the bailee or the holder
must be of the same skill or labour that the goods are being held for.
There are two types of lien:

Particular Lien: When the holder holds the property which is in connection with the due
payment and then releases the property once the due amount is received.

General Lien: When the holder holds a property that might not have a connection to the
payment due they can hold off to anything that is of similar value as to the amount due even
if the item is not connected to the payment due.

In particular lien in the case of Hatton V. Car Maintenance Company, Ltd. it was stated by
the court that the lien can only be exercised on the goods on which the payment is due when
the work on the item is done for its improvement or to make it better. Unlike in this case
where the item was supposed to be maintained not improved the right of lien for the repairer
never existed in the first place.

Therefore, it was concluded that a lien does not exist for each and every case.

Banker's Lien

Bank's power to practice lien

A banker's lien, when it is not excluded by special contract, express or implied, extends to all
bills, cheques, and money entrusted or paid to him, and all securities deposited with him, in
his character as a banker. Strictly, it is confined to securities and properties in the custody of
the banker; and in respect of things that belong to the customer, and are held by the bank as
security; whether they are in the same or different branches. If a thing is in possession of the
bank but owned by the customer, has no right of lien over it. A deposit of valuables with a
banker is subject to the banker's lien for the customer's general debts to him unless can prove
an agreement to give up his general lien. Thus, if a certain sum is due to a bank in one
account, it may retain as security or other movable that came into its hand in another account;
including repayment of subsequent advances. A banker's lien would also apply to negotiable
instruments remitted by the customer for collection. Unless otherwise directed, the proceeds
of such collection may be used by the bank for reducing the customer's debit balance.

The Banker's lien, apart from any specific security, the banker can look to his general lien as
a protection against loss on loan or overdraft or another credit facility. The general lien of
bankers is part of law merchant and judicially recognised as such.1

When is Lien not permissible

Lien is not permissible in the following cases:

Where there is an express contract like by way of counter-guarantee, providing

reimbursement. (Krishna Kishore Kar v. United Commercial Bank)

Where there is no mutual demand existing between the banker and the customer firm.
(Jaikishan Dass Jinda Ram v. Central Bank of India)

Where the valuables are received for safe custody. (Cuthbert v. Roberts4 and Bank of Africa
and Cohen)

Where the entrustment of goods (documents of title) is for a specific purpose stated to the
banker. (Greenhalgh v. Union Bank of Manchester)

When the deposit with the banker is for a specific purpose if the banker has implied or
expressed notice of such purpose.

Where the valuables or documents of title are left in the banker's hands, inadvertently.

Where the banker has only a contingent debt. A contingent debt is that "no amount would be
due on the date when he wants to exercise lien" Tannans banking Law.

Where the account is in respect of a trust.

Banker's Lien is not available against Term Deposit Receipt in Joint Names when the debt is
due only from one of the depositors.
What Is a Bank Guarantee?

A bank guarantee is a type of financial backstop offered by a lending institution. The bank
guarantee means that the lender will ensure that the liabilities of a debtor will be met. In other
words, if the debtor fails to settle a debt, the bank will cover it. A bank guarantee enables the
customer (or debtor) to acquire goods, buy equipment, or draw down a loan.

Bank Guarantee

Understanding Bank Guarantees

A bank guarantee is when a lending institution promises t o cover a loss if a borrower

defaults on a loan. The guarantee lets a company buy what it otherwise could not, helping
business growth and promoting entrepreneurial activity.

There are different kinds of bank guarantees, including direct and indirect guarantees. Banks
typically use direct guarantees in foreign or domestic business, issued directly to the
beneficiary. Direct guarantees apply when the bank’s security does not rely on the existence,
validity, and enforceability of the main obligation.

Individuals often choose direct guarantees for international and cross-border transactions,
which can be more easily adapted to foreign legal systems and practices since they don't have
form requirements.

Indirect guarantees occur most often in the export business, especially when government
agencies or public entities are the beneficiaries of the guarantee. Many countries do not
accept foreign banks and guarantors because of legal issues or other form requirements. With
an indirect guarantee, one uses a second bank, typically a foreign bank with a head office in
the beneficiary’s country of domicile.
Examples of Bank Guarantees

Because of the general nature of a bank guarantee, there are many different kinds:

A payment guarantee assures a seller the purchase price is paid on a set date.

An advance payment guarantee acts as collateral for reimbursing advance payment from the
buyer if the seller does not supply the specified goods per the contract.

A credit security bond serves as collateral for repaying a loan.

A rental guarantee serves as collateral for rental agreement payments.

A confirmed payment order is an irrevocable obligation where the bank pays the beneficiary
a set amount on a given date on the client’s behalf.

A performance bond serves as collateral for the buyer’s costs incurred if services or goods are
not provided as agreed in the contract.

A warranty bond serves as collateral ensuring ordered goods are delivered as agreed.

For example, Company A is a new restaurant that wants to buy $3 million in kitchen
equipment. The equipment vendor requires Company A to provide a bank guarantee to cover
payments before they ship the equipment to Company A. Company A requests a guarantee
from the lending institution keeping its cash accounts. The bank essentially cosigns the
purchase contract with the vendor.

The World Bank also offers a bank guarantee program. Project-based loan guarantees by the
World Bank provide commercial lenders security against payment default or failure to meet
performance obligations by governments.1

What Are the Different Types of Bank Guarantees?

There are two key types of bank guarantees—a financial bank guarantee and a performance
guarantee. Financial bank guarantees are for debts owed, while performance-based
guarantees are for obligations laid out in a contract, such as particular tasks.

What Is the Financial Instrument for a Bank Guarantee?

The financial instrument used in a bank guarantee is called a banker's acceptance.

KEY TAKEAWAYS

A bank guarantee is when a lending institution promises to cover a loss if a borrower defaults
on a loan.

Parties to a loan choose direct guarantees for international and cross-border transactions.

The guarantee provides additional risk to the lender, so loans with such a guarantee will come
with greater costs or interest rates.

What Is A Letter of Undertaking (LOU)?

A. There is a widely accepted provision of bank guarantees known as a letter of undertaking

(LOU) under which a bank can allow its customer to raise money from another Indian bank's
foreign branch in the form of a short-term credit. The LOU serves the purpose of a bank
guarantee for a bank's customer for making payment to its offshore suppliers in the foreign
currency.

B. For raising the LOU, the customer (importer) is supposed to pay margin money to the
bank that issues the LOU and accordingly, they are granted a credit limit. But in Nirav Modi's
case, neither was there a credit limit, nor did he ever give any margin money, reported
Reuters.
C. Once the letter of credit is acknowledged and accepted, the lender (foreign branch of
Indian bank) transfers money to the nostro account of the bank that has issued the LoU. In
this case, Nostro account is the Punjab National Bank's account held in another bank in a
foreign country for the purpose of holding foreign currency.

D. As a matter of fact, letter of undertaking is a letter of credit issued by one bank (let's call it
Punjab National Bank) that paves way for another bank (let's call it Allahabad Bank-AB) to
give money to supplier of Punjab National Bank's customer. As mentioned earlier, the money
is transferred by AB to supplier of PNB's customer via a nostro account that PNB holds in
AB in abroad.

E. The credit is ideally meant for short-term only. In the Nirav Modi-Mehil Choksi case, the
term of loan was allegedly extended far beyond what is prescribed as per the rule book. Even
the PNB and other lenders are slugging out over the loan term, which should not have been
extended, says PNB, longer than 90 days.

City Union Bank Ltd.v.Thangarajan (2003)46 SCL 237 (Mad) it is pertinent to state certain
principles with respect to Banker’s lien that was observed.

The bank gets a general lien in respect of all securities of the customer including negotiable
instruments and FDR s, but only to the extent to which the customer is liable. If the bank fails
to return the balance, and the customer suffers a loss thereby, the bank will be liable to pay
damages to the customer.
In the present matter the Court has based its decision on the principle that in order to invoke a
lien by the bank, there should exist mutuality between the bank and the customer i.e. when
they mutually exist between the same parties and between them in the same capacity.
Retaining the customer’s properties beyond his liability is unauthorized and would attract
liability to the bank for damages.