CHEQUES

A Cheque is a negotiable instrument instructing a financial institution to pay a specific amount of a

specific currency from a specific demand account held in the depositor’s name with that institution. It is
defined as a written order of a depositor upon a bank to pay a specified sum of money on demand. The
demand could be

a) To pay to the person him/herself – Open Cheque

b) To pay to the order of a designated party – Order Cheque

c) To pay to any person who has the cheque – Bearer Cheque

The person who writes the cheque is called the Drawer. The bank on which the cheque is drawn is
called Drawee. The person to whom payment is to be made is called Payee.

Features of a cheque

i. A cheque must be in writing and duly signed by the drawer.

ii. It contains an unconditional order.

iii. It is issued on a specified banker only.

iv. The amount specified is always certain and must be clearly mentioned both in figures and words.

v. The payee is always certain – either with a name, designation or for the Bearer.

vi. It is always payable on demand.

vii. The cheque must bear a date otherwise it is invalid and shall not be honored by the bank.
Types of Cheque

Broadly speaking, cheques are of four types.

a) Open Cheque: A cheque is called ‘Open’ when it is possible to get cash over the counter at the bank.
The holder of an open cheque can do the following:

i. Receive its payment over the counter at the bank,

ii. Deposit the cheque in his own account

iii. Pass it to some one else by signing on the back of a cheque (Endorsement).

b) Crossed Cheque: Since open cheque is subject to risk of theft, it is dangerous to issue such cheques.
This risk can be avoided by issuing another type of cheque called ‘Crossed Cheque’. The payment of
such cheque is not made over the counter at the bank. It is only credited to the bank account of the
payee. A cheque can be crossed by drawing two transverse parallel lines across the cheque, with or
without the writing ‘Account payee’ or ‘Not Negotiable’. An example is shown below;

c) Bearer Cheque: A cheque which is payable to any person who presents it for payment at the bank
counter is called ‘Bearer cheque’. A bearer cheque can be transferred by mere delivery and requires no
endorsement.

d) Order Cheque: An order cheque is one which is payable to a particular person or holding a certain
designation. In such a cheque the word ‘bearer’ may be cut out or cancelled and the word ‘order’ may be
written. The payee can transfer an order cheque to someone else by signing his or her name on the back
of it (Endorsement).
Parts of a Cheque

MICR

The Bank Sort Code and Account Number at the bottom of the cheque is normally written using
Magnetic Ink Characters that are machine readable and thus eliminate human errors while sorting
cheques. The use of magnetic printing allows the characters to be read reliably even if they have been
overprinted or obscured by other marks, such as cancellation stamps and signature. A specimen is shown
below

The aim of MICR is to enhance security and minimize fraud since any cheque without the magnetic ink
would be rejected by the MICR scanner used by banks. Therefore, the main advantages of MICR are
that the cheques cannot be forged easily and can also be read if the text is disfigured in some way. The
machine automatically reads most of the information off the cheque – saving time and human errors.
However, banks have to invest in expensive MICR readers in order to adapt to this technology. Also, the
scanner is designed to read only a few specific characters.

Crossing of Cheques

A cheque is said to be crossed when two transverse parallel lines are drawn across its face or on the top
left corner of the cheque. The lines may or may not have any words written between them. Crossing may
be written, stamped, printed or perforated. It is a direction to the paying banker to pay the money
directly to any banker or a specific banker and NOT to the holder at the counter. Crossing increases the
security and protection to the true owner of the cheque in various ways

i. The payment is made from one bank to another and therefore the transfer of money is traceable.
In event of an error, the payment can be easily reversed.

ii. It avoids losses that may result from open cheques falling into the hands of wrong people.

The cheque may be crossed by the drawer himself before issuing it. Where a cheque is uncrossed, the
holder may cross it generally or specifically. Cancellation of a Crossing, also known as Opening of
Crossing can be done only by the drawer of the cheque. The drawer, after cancelling the crossing, will
put his signature and write ‘Pay Cash’ on the cheque.

Modes of Crossing

A bank usually refuses to immediately exchange a crossed cheque for cash when presented in person by
the payee. Because a cheque may easily fall into the wrong hands, banks and customers during the last
century devised special markings which constitute particular instructions to the bank. These markings
are called crossings.

CROSSING

General Crossing Special Crossing

General Crossing

Where a cheque bears across its face two transverse parallel lines with or
without any words, it is called general crossing. In this case, the banker will
make the payment only to some other banker.

Account Payee Crossing – increases the security of the cheque by

mentioning the amount should be credited only in the account of the payee mentioned on the cheque.

Special Crossing

Where a cheque bears across its face an addition of the name of a banker with or without the words ‘not
negotiable’, it shall be deemed to be a special crossing. When a cheque has been specially crossed, the
banker upon whom it has been drawn will make the payment only to that banker in whose favor it has
been crossed.

Double Crossing – when a cheque bears two separate special crossings, it is said to have been doubly
crossed. Such cheques are normally denied payment as they mention the name of two banks as recipient
of funds. A paying banker pays such a cheque only if one of the bank’s mentioned is the other bank’s
agent for collection of cheques.

Negotiability of a Cheque

A cheque, by definition, is a negotiable instrument. They are not merely orders to a bank to make a
payment, they are transferable orders and, if not marked 'not negotiable', they are negotiable
instruments. It is important to remember, however, that even when the cheque is marked Not
Negotiable, its transfer cannot be restricted (it can still be given to others). Negotiability implies its
ownership is transferable freely. There are two ways of negotiating a cheque

1. If the cheque is a Bearer Cheque, it can be transferred by just delivery.

2. If the cheque is to order then it can be transferred through endorsement and delivery.

The 'holder' of a bearer cheque is the person in possession of it. The 'holder' of an order cheque is either
the original payee of the cheque who is also in possession of it, or a person to whom the cheque has been
transferred by negotiation.

Endorsement

Endorsement means writing of a person’s name on the back of the instrument for the purpose of
negotiation i.e. changing ownership. A person who endorses a cheque also makes promises to later
holders. The most important of these promises is that the bank will pay the cheque and, if it does not, the
endorser will pay.
Types of Endorsements

Not Negotiable

The ordinary rule for the transfer of personal property, to protect original ownership, is that the
transferee (receiver) of the property can take no better title than that of the transferor (even in good
faith). Thus, if the transferor steals a car and sells it, the buyer will have to return it to the original
owner, even if he bought it in good faith. That rule does not apply to negotiable instruments. It is
possible for a holder to obtain a good title even when the transferor has a defected title. Such a holder is
referred to as a Holder in Due Course.

A 'holder in due course' is a holder who has taken a negotiable cheque in

1. Good faith – with fair and legal intentions

2. For value – by providing some product or service in return of the cheque

3. With no notice of any defect in title of the transferor, and

4. The cheque itself is complete and regular on the face of it.

The effect of being a 'holder in due course' is that the holder takes the cheque free of any defects in title
of his predecessor.

By comparison, when a person takes a crossed cheque which bears the words 'not negotiable' written
between the lines (or a cheque simply marked with two parallel lines across it), they shall not have and
shall not be capable of giving a better title to the cheque than that which the person from whom they
took it had. In other words, there is no such thing as a holder in due course of a cheque which is crossed
and marked 'not negotiable'.

The words 'not negotiable' between two lines does not stop a cheque from being transferred. Both bearer
cheques and order cheques may be transferred from person to person in the same way that cheques
without the marking may be transferred. But if the cheque is lost or stolen, the person who lost it or the
person from whom it was stolen still retains ownership of the cheque and may raise the fact that it was
lost or stolen as a defense against anyone who attempts to claim on the cheque.

As an example, consider if a cheque is given by the drawer D to the payee P as payment for goods and
the cheque is stolen by T and handed to a grocer G as payment for groceries. These variations of the
example show how the ownership of a cheque may be changed to the detriment of an earlier holder
where the cheque is:

• an uncrossed bearer cheque - G becomes the holder (owner) in due course and is entitled to the
cheque. Neither D nor P may complain
• an uncrossed order cheque - T must forge P's endorsement to transfer the cheque to G. G has no
right to the cheque as ownership cannot be acquired through the forged endorsement
• crossed and marked 'not negotiable' - G obtains no rights to the cheque as T had no rights.
Payment of Cheques

Cheque is an order of the customer without condition. It is drawn upon a certain bank in writing. The
banker has always to pay it on demand unless any of the following conditions persists; in which case
Dishonor of Cheque is granted. These conditions are

i. Drawer’s signature differs

ii. Notice from the drawer to stop payment – countermanding payment

iii. Cheque is stale

iv. Mutilated cheque – torn or damaged

v. Overwriting on cheque

vi. Amount in words and figures differ

vii. Payment is stopped by court – garnishee order

viii. Insufficient credit balance in drawer’s account

Wrongful Dishonor and Effects

The relationship between the payer bank and the depositor is that of a debtor and creditor. The bank's
obligation is to pay all checks properly presented to it when they are covered by sufficient deposits, in
consideration of the deposit by the customer. Failure of a bank to honor a valid and payable cheque
within a statutory period (usually until midnight of the day of presentment) is called Dishonor of
Cheque. The cheque might be dishonored because of the customer’s fault or because of the banker’s. In
case of the customer’s fault full responsibility of the error goes to the customer but the liability is not
very huge. On the other hand, if the error is made by the banker and the bank's customer suffers
provable harm, the bank may be liable for damages more than the original amount on the cheque.

Therefore, dishonor is considered Wrongful if the cheque is valid but still does not receive payment
from the banker. Dishonor can be due to the following reasons

1. Non Acceptance of Cheque

2. Non Payment of Cheque

Consequences of Wrongful Dishonor

Failure of a bank to pay on a properly presented check creates a far different impact than the normal
failure of a debtor to pay. The bank in such cases, by its wrongful dishonor, is said to have cast a shadow
on the reputation and character of the depositor and to have left the depositor open to criminal
prosecution under "bad cheque" laws. There is no debate that in case of wrongful dishonor, the banker is
liable for damages.

Restitutio in Intgegram – to restore the customer to the position he would have been in if he had not
suffered a damage. This is the principle normally followed by the court in order to calculate
compensation payable by the banker. The general rule is to compensate for actual and foreseeable loss
incurred by the customer due to the banker’s mistake. Damages may fall in any of the three categories

- Nominal Damages: amount naturally ensuing from the dishonor is paid.

- Substantial Damages: more compensation is given because of loss of trust and good will.

- Other Damages: compensation of an amount that reasonably covers the indemnity.

Wrongful Dishonor exposes the bank to the liability of compensating the customer for any loss or
damage caused by such default. The compensation is awarded by taking into consideration the damage
caused or likely to be caused in the future because of the dishonor. Though the judgment of the court
differs from case to case, it is normally seen that traders and businessmen qualify for Substantial
Damages while non traders, in absence of strong proof, are only eligible for Nominal Damages. This is
because traders have goodwill to protect in the market and their loss is greater if they fail to make
payment. Similarly, the compensation made by the banker in case the value of the cheque is less. This is
normally because when the cheque is of a less amount its default causes more damage to the reputation
of the drawer.

Protection given to Bankers – the Concept of Payment in Due Course

The banker is protected through Indian regulations in case payment is made for

- Crossed Cheques: cheques to which cash is not payable over the counter.

- Uncrossed Cheques: cheques that can grant payment in cash to the payee.
- Demand Drafts: money drawn by one bank upon another office of the same bank.

The protection is only applicable if it is proven in the court of law that the banker made the payment in
Due Course. In order to be considered as Payment in Due Course, the banker’s action must follow
certain criteria

- Payment in accordance with the tenor of the cheque

- Payment in good faith and without negligence

- Payment under reasonable grounds that the presenter of the cheque is entitled for payment.

Payment in accordance with tenor of the cheque implies that it must be in accordance with the intention
of the drawer, as shown on the face of the cheque. It is the banker’s responsibility to follow all the
instructions given on the cheque like date, amount, name of the payee, endorsements etc. For example, if
a banker makes payment of a post dated cheque prior to its date of issue, it shall not be considered
payment in due course. Similarly, if a banker makes payment in cash on the counter for a crossed
cheque, it shall not be considered payment in due course.

It is essential that payment is made in good faith. This means that the banker, at the time of acceptance,
should have no doubt that the cheque is valid. If the banker is not negligent in any way and confirms to
the best of his ability that there is nothing wrong with the instrument, payment shall be considered as
payment in due course. This puts the banker in a difficult state as it is very difficult to prove in the court
of law that the banker was not negligent at the time of accepting the cheque. Common example of such
negligence is accepting a cheque with a forged signature

Lastly, the banker should ascertain that the presenter of the cheque is in everyway entitled to receive
payment for the cheque. A cheque that has been countermanded by the issuer cannot be drawn by any
presenter, and if the banker makes payment it cannot be considered payment in due course.

Mistakes of a Banker

Despite of all precautionary measures, a banker may make the payment of a cheque by mistake.
Mistakes are sometimes unavoidable and therefore the question is not of how to eliminate the mistakes
but whether or not the money paid by mistake can be recovered! In order to understand the banker’s
chances of recovery, certain instances are important to consider. They are illustrated below and highlight
when a banker can expect recovery of amount.

Mistakes made by the banker can be classified into two types

1. Mistake of Fact – mistakes that exist between the payer and the receiver and involved the actual
transaction.

2. Mistake of Law – mistakes that involve negligence regarding banking regulations or proper code of
conduct.

Banker’s Mistakes

Mistake of Fact Mistake of Law

Holder in Due Bank’s

Course Customer Recovery Not
Possible
* Banker is expected to know
and respect the law; ignorance
Holder is a Holder is Incorrect Incorrect of law cannot form an excuse
Fraud Bonafide Debit Credit for defense in Court.

Position Position Recovery Possible with

Altered Same Customer Consent

Recovery Not
Recovery Not Possible
Possible

Recovery Recovery
Possible Possible

As illustrated, mistakes of law put bankers in a position where the amount is irrecoverable. Where the
mistake is that of fact, chances of recovery depend on whether or not the recipient of funds was bonafide
(truly eligible for receiving amount). It should be remembered that where ever recovery is possible, it is
not confirmed that the money will in fact be recovered; the banker can just try to claim the funds back.
Collection of Cheques

Bankers must take reasonable care whilst accepting cheques from their customers. Though mistakes
cannot be completely eliminated, the following careful measures should be taken while handling
cheques for payment

1. Collecting banker should act in good faith

2. The banker must carefully examine the endorsements on the cheque

3. Exercise care while accepting cheques that require payment from

- a company’s account to a private account of its employees

- a principal’s account to his agent’s account

- a partnership account to the private account of a partner

- a customer’s official account to this private account.

4. Care should be taken while making payments for cheques of large amounts that are incompatible with
the customer’s income or regular transactions.

5. Try to obtain guarantee for endorsements made by the payee

6. Make sure that the customer has not be negligent while handing out the cheque

7. Always ask for reference when new customers come to open an account

8. Care should be taken while handling cheques “Account Payee” by someone other than the payee
himself.

9. Exercise due diligence while accepting cheques which are marked Not Negotiable, Not Transferable
or Crossed in any other form.

10. Cheque should be collected from only a customer of the banker.