Understanding Negotiable Instruments vs. Letters of Credit
A negotiable instrument is a legal document representing an unconditional promise or order to pay a specific sum of money, either on demand or at a future date. These instruments are crucial in commerce because they can be easily transferred from one person to another, allowing for smooth financial transactions.
Key Features of Negotiable Instruments
To be considered a negotiable instrument, a document typically needs to meet certain criteria:
- It must be in writing.
- It must contain an unconditional promise or order to pay a definite sum of money.
- It must be payable either on demand or at a specific future time.
- It must be payable to the order of a specific person or to the bearer (the person possessing it).
Analysis of Options
Let's examine the provided options in the context of negotiability:
| Instrument Type | Is it Negotiable? | Explanation |
| Bill of exchange | Yes | This is a written order from one party (drawer) to another (drawee) to pay a specified sum of money to a third party (payee) or the bearer. It's a core example of a negotiable instrument. |
| Promissory notes | Yes | This is a written promise by one party (maker) to pay a specified sum of money to another party (payee) or the bearer. It embodies an unconditional promise. |
| Bearer Cheques | Yes | A cheque payable to the person who holds it (the bearer). It's a specific type of bill of exchange and is readily transferable by mere delivery. |
| Letter of credit | No | This is an undertaking by a bank, issued at the request of a customer, guaranteeing payment to a beneficiary upon the presentation of specified documents that comply with the terms of the credit. |
Why a Letter of Credit is Not a Negotiable Instrument
A Letter of Credit (LC) differs significantly from the other options. While it facilitates payment, it is fundamentally a conditional undertaking by a bank. Key differences include:
- Conditionality: Payment under an LC is contingent upon the beneficiary presenting specific documents (like invoices, shipping documents, etc.) that exactly match the requirements stipulated in the LC. This contrasts with negotiable instruments, which are typically payable based on the instrument itself without requiring further documentary proof of compliance.
- Documentary Nature: The process revolves around the exchange and verification of documents. The bank deals primarily with documents, not necessarily the goods themselves.
- Bank's Guarantee: It's a bank's guarantee of payment, subject to terms, rather than a direct promise or order from one party to another for payment.
Because of its conditional nature and reliance on specific documentary compliance, a Letter of credit is not considered a negotiable instrument in the same vein as bills of exchange, promissory notes, or bearer cheques.
Important Questions from Negotiable instrument Act, 1881
- Which of the following is not true in the context of a promissory note?
- Given below are two statements, one labelled as Assertion (A) and the other labelled as Reason (R). Read the statements and choose the correct answer using the code given below.
Assertion (A) : A 'negotiable instrument' means a promissory note, bill of exchange or cheque payable either to order or to bearer.
Reason (R) : Because it is said so under Section 13 of the Negotiable Instruments Act, 1881. - Read Assertion (A) and Reason (R) and answer using code below :
Assertion (A) : Where a bill is unintentionally cancelled by the holder or his agent and the cancellation is not apparent thereon, the bill is discharged.
Reason (R) : Above principle is laid down in Section 82 of the Negotiable Instruments Act.
Code : - Which one of the following statements is true ?
- Match List – I with List – II and select the correct answer using the codes given below :
List – I List – II i. Inchoate stamped instrument a. Union Bank of India Vs. Ankur Corp. ii. Liability of acceptor of a negotiable instrument b. Section 31 of the Negotiable Instrument Act iii. Liability of an endorser c. Section 35 of the Negotiable Instrument Act. iv. Liability of the drawee of a cheque. d. Section 20 of the Negotiable Instrument Act.
Codes :
