Short notes on the Capacity of parties holders in due course

i. Capacity of Parties

ii. Holder of Parties

iii. Essential Conditions of a holder

Every person capable of entering into a contract may bind himself and be bound by making, drawing, acceptance, endorsement, delivery and negotiation of a promissory note, bill of exchange or cheque. However, any incompetent party, i.e., a minor may draw, endorse, deliver and negotiate such instruments so as to bind other competent parties but not himself (i.e., incompetent party will not be bound) (Sec. 26).

Thus, it would be seen that incapacity of one or more parties to a negotiable instrument does not affect the capacity of the other competent parties, as such they continue to be liable on the instrument.

Let us examine the Position of Some of these Persons One by One :

1. Minors:

A minor cannot bind himself under a negotiable instrument as his contract is absolutely void. However, as pointed out above, a minor can draw, endorse, negotiate instruments so as to make other persons liable, but not himself. A minor can acquire rights under a negotiable instrument. As such if a minor is a payee under a negotiable instrument, he can enforce payment. As usual, he can plead infancy and escape liability even where he has misrepresented his age.

2. Persons of unsound mind:

The position of persons of unsound mind, i.e., lunatics, ingots and drunken persons is the same as that of a minor. However, a lunatic or a drunken person who has become a party to a negotiable instrument during lucid interval or while he was in his senses, shall be liable on the instrument.

3. Insolvents:

A person on being declared insolvent cannot enter into a contract. As such, an insolvent person cannot become a party to a negotiable instrument. However, if he becomes a party to such an instrument, he incurs no liability and acquires no right as his rights vest in the official recovered or assignee if he intervenes. But other parties to the instrument continue to be liable.

4. Corporation or a company:

Although a company has contractual power, yet every company has no power to draw, accept or endorse a bill of exchange. A trading company has power to draw, accept and endorse bills and note in the ordinary course of its business but a non-trading company has no such implied power. It must be expressly authorized by its Memorandum or Articles to draw, accept or endorse bills or notes. It should be noted that a trading as well as, non-trading company has the power to issue cheques.

5. Agent, a person capable of contracting, may make, Draw, accept, endorse, deliver and negotiable a bill, note or cheque either himself or though a duly authorized agent acting in his name. As such it should be noted that a general authority to transact business and to receive and discharge debts on behalf of the principal does not empower an agent to draw, accept or endorse bills of exchange. Again, mere authority to draw does not mean authority to accept them. Likewise, mere authority to accept them does not imply authority to endorse them (Sec. 27).

An agent may sign on behalf of his principal in the name of the principal or in his own name indicating that he is signing as an agent by using such words as 'for' or 'on behalf of, etc.

Personal Liability of an Agent :

Where the agent signs in his own name but does not indicate that he is signing only in the capacity of an agent or he exceeds his authority, he will be personally liable. It should be noted that an agent is personally liable even when he does not disclose the name of the principal or where the principal cannot be sued, e.g. if he is a minor.

6. Partners:

A partner of a trading firm has an implied authority to draw, accept or endorse bills and notes. However, a partner of a non-trading firm has no such implied authority to bind the firm. For example, a partner of firm of chartered accountants cannot accept a bill of exchange.

7. Joint Hindu Family:

The manager or 'Karta' of a joint Hindu family has the power to bind the other members of the family by his acts. As such he has an implied power to draw, accept or endorse bill and notes for the business of the family. He has an implied power to draw, accept or endorse bills and notes for and on behalf of the Joint Hindu Family. All the other members are also liable but minors are liable to the extent of their shares in the family business. They are not, in any way, personally liable.

However, there is a conflict of opinion among the various High Courts on the point. The underlying reason is that no person can be sued on a negotiable instrument unless his name appears as a party on the negotiable instrument. Therefore, other members whose names do not appear on the instrument will not be liable.

8. Legal Representative (Sec. 29):

A legal representative of a deceased person, who signs his name on a promissory note, bill of exchange or cheque is liable personally thereon unless he expressly limits his liability to the extent of the assets received by him. Thus, in the absence of an express contract to the contrary, the liability of a legal representative is unlimited. However, a legal representative may, by an express agreement, limit has liability. Further, he may exclude his liability, i.e., by adding the words "Sans recourse or without recourse".

9. Endorsement by Legal Representative:

A legal representative is not an agent of the deceased. Therefore, a legal representative cannot complete the instrument if the instrument was executed by the deceased but could not be delivered because of his death.

Example:

A, the holder of a bill, B before delivering the bill died the legal representative subsequently delivered the bill to B. The endorsement is invalid and B cannot sue on the bill.

Parties to a Negotiable Instrument :

Parties to a Promissory Note:

1. The Maker:

The person who makes or executes the promissory note is called 'maker'. It should be noted that the maker of a bill or cheque is called 'drawer'.

2. The Payee:

The person to whom the payment of the instrument is to be made is called 'Payee'.

3. The Holder:

The original payee or any other person to whom the payee has indorsed the instrument is called the 'holder'. In case of bearer instrument, the bearer will be the holder.

4. The Indorser:

'Indorsees the person who indorses or transfers the instrument. When the holder transfers the instruments, he becomes the indorser.

5. The Indorsee:

'Indorsee' is the person to whom the instrument is indorsed or transferred.

Parties to a Bill of Exchange:

The Drawer:

The person who draws the bill or cheque.

(i) The Drawee:

The person on whom the bill is drawn.

(ii) The Acceptor:

The person who accepts the bill. The drawee when accepts a bill becomes 'the acceptor' Ordinarily, it is the drawee who accepts the bill. However, a stranger may accept a bill on behalf of the drawer. He is called 'drawee' in case of need. Refer to the Drawee in case of need discussed later.

(iii) The Payee:

The person to whom or to whose order the bill or note is payable. The drawer of any person may be the payee.

(iv) The Holder:

Indorser and Indorsee are the same as in the case of a promissory Note.

6. The Drawee in case of need:

Where the drawer is afraid that the drawee may not accept the bill he may give the name of the person in addition to the drawee. Such a person is called 'drawee in case of need'. In such a case, it would be obligatory for the holder to present the bill to the drawee in case of need, if the original drawee refuses to accept the bill. Only when the drawee in case of need also refuses to accept or pay the bill, the bill will be considered dishonoured for non-acceptance or non-payment. V

7. The acceptor for honour:

As a rule, it is the drawee who can accept a bill. However, Sec. 7 provides that when a bill has been noted or protested for non-acceptance or for better security, any person who is not already liable on the bill, may accept it with the consent of the holder, for the honour of any party liable on the bill. Such an acceptor is called 'acceptor for honour'.

Parties to a Cheque :

The drawer, drawee, payee, holder, indorser and indorsee are the same as discussed in case of a bill or note. However, it should be noted that in case of a cheque, drawee is always a specified bank in which the drawer has opened the account. Again in a cheque or bill, the drawer and the payee may be one and the same person.

Holder and Holder in due Course :

'Holder' of a promissory note, bill of exchange or a cheque means any person entitled in his own name to the possession thereof and to receive or recover the amount thereon from the parties thereto (Sec.8).

Essential Conditions of a Holder :

(i) He should be entitled in his own name to the possession of the instrument.

(ii) Either he has the possession or he is entitled to recover the possession.

(iii) He should be a de jure (in law) holder and need not be a de facto (in fact) holder, except in case of a bearer instrument. Thus, a person who is not actual possession of an instrument but is entitled to the possession of the instrument is a holder.

Example:

A lost his cheque. It is found by B, B is in actual possession but A being the owner, is entitled to the possession of the cheque. Hence, B is not a holder, although he is in possession of the cheque. Here A is the holder, although cheque is not in his possession yet he is entitled to the possession of the instrument in his own name.

A holder, in case of an instrument payable to order, is a payaee or indorsee. In case the instrument is payable to bearer, holder means the possessor of the instrument. Thus, a benamidar or a trustee or a guardian who has taken the instrument in his own name, is holder. A beneficial owner is not a holder because he is not entitled to the instrument in his own name.

Holder in due Course :

One of the important characteristics of a negotiable instrument is that the transferee acquires a better title. However, it is possible only when the transferee is a holder in due course. Let us, therefore, examine who is a holder in due course?

A holder in due course is a person who acquires a promissory note, bill or cheque bona fide, for value and before maturity (Sec. 9).

A holder in due course must satisfy the following conditions :

1. He became the holder of valuable consideration:

For consideration he became possessor of the instrument is payable to bearer, or payee or indorsee, if the instrument is payable to order.

2. He became the holder before maturity of the instrument:

For a bill or note, he should have become a holder before maturity. However, for a cheque, there is no question of maturity (Though the cheque becomes stale after the expiry of six months from the date of its issue as per practice). Therefore, it cannot be called a holder in due course. Consequently, he will not get a better title than that of the transferor.

3. He became the holder bona fide i.e., in good faith:

He became a holder without having sufficient cause to believe that any defect existed in the title of the person from whom he took it, or derived his title.

The test of good faith is whether he took the instrument honesty and with due care. If yes, he acquired it in good faith, otherwise not. He should not have been negligent at the time of taking an instrument. If a person has suspicion at the time of taking an instrument that there was something wrong on the part of the person transferring the instrument, he will not be a holder in due course. He must make enquiry so as to find out the truth. If due course not make any enquiry in such a case, he cannot be called a holder in due course.

Example:

(i) A bill which has been torn up into pieces and pasted together, creates a doubt. It is just possible that the payee might have cancelled it by tearing.

(ii) Where alteration is apparent on the face of it.

4. Finally, he should not have notice of defects, whether actual or constructive:

Notice should be in relation to defects of the person from whom he took it. A defect in the title of prior party does not affect the title of the holder.

Example:

Defendants Nos. 2 to 4 who were partners of a firm (Defendant No.l) supplied certain goods to defendant No. 6. Defendant No. 6 issued two cheques in favour of the firm in part payment of the cost of goods. The cheques were purchased by the plaintiff bank and their proceeds were credited to the account of the firm and the amount was withdrawn on various dates, when the cheques were presented for payment, these were returned with an endorsement "full cover not received". It was contended that the plaintiff bank was only a collecting agent; that there was no consideration for the payment of cheques and he was not a holder in due course. Further the plaintiff had acted negligently and as such, had no cause of action against the defendant

The Trial Court and the High Court held that the plaintiff was entitled to enforce the liability against the defendant, the maker of the cheques. The Supreme Court held that the plaintiff was a holder in due course for valid consideration.

He could validly maintain action against all the defendants. Under the Indian law, a holder in due course must not only acquire the bill, note or cheque for valid consideration but should have acquired the cheque without having sufficient cause to believe that any defect existed in the title of the person from whom he derived his title. This condition requires that he should act in good faith and with reasonable caution. However, mere failure to prove bona fide or absence of negligence on his part would not negate his claim. In the instant case, the plaintiff bank provided credit to defendants Nos. 2 to 4 and the 5th defendant (mother of defendants Nos. 2 to 4) who pledged the title deeds to secure the credit. Held in view of this, the plaintiff need not make enquiries about the transaction of supply of goods, etc, and there was no sufficient cause for the plaintiff to doubt the title of defendant No. 1 nor can it be said that the plaintiff acted negligently disregarding "red flag" raising suspicion. [U. Ponnappa Mothan Sons v. Ca Catholic Syrian Bank Ltd.

Privileges of a Holder in due Course :

The law has given some privileges, i.e. special rights to a holder in due course. A holder in due course acquires good title to the instrument, even if the title of the transferor was defective. The defect of title is purged (washed) when the instrument passes through the hands of a holder in due course. Thus it is like 'Gangajee' (The River Ganges) where it is believed that a person by taking a bath can wash all his sins. A holder in due course has the following privileges:

1. Estoppel against inchoate stamped instrument (Sec. 20):

A person who has signed and delivered to another a stamped but otherwise inchoate instrument cannot avoid his liability to a holder in due course on the ground, that the instrument has not been filled in accordance with the authority given by him.

2. Every prior party is liable to a holder in due course (Sec. 42):

Every prior party to a note, bill or cheque is liable to a holder in due course until the instrument is satisfied or discharged.

3. Acceptor cannot escape liability on a fictitious bill on a bill (Sec. 42):

Where a bill is drawn payable to drawer's order in fictitious name and is indorsed in the same hand as drawer's signatures, the acceptor cannot avoid his liability to a holder in due course on the ground that such name was fictitious.

4. Not affected by Conditional or special purpose delivery:

A party cannot avoid his liability to a holder in due course on the ground that the delivery of the instrument was conditional or for a special purpose only.

5. Not affected by the fraud of a prior party:

If an instrument was obtained by fraud, the holder in due course is not affected by the fraud of such prior party.

Example:

A, by fraud obtains a bill from B, A indorses the bill to C, holder in due course. B cannot avoid his liability on the ground that A has obtained the bill from him by fraud, of course. Between immediate parties i.e., A and B, such a plea is admissible. Thus before the bill is indorsed to C, B can recover the bill from A on the ground of fraud.

6. Not affected even if instrument obtained by unlawful means or for unlawful consideration (Sec. 58):

When an instrument has been lost or has been obtained by means of a fraud or for unlawful consideration, holder in due course is not affected thereby.

7. Every holder is presumed to be a holder in due course (Sec. 118):

Every holder is presumed to be a holder in due course until the contrary is proved.

8. Acceptor for honour cannot deny his liability to a holder in due course (Sec. 100):

The maker or acceptor of a bill for the honour of the drawer cannot escape his liability on the ground that he accepted the bill only for the honour of the drawer and no one else.

9. Maker and acceptor of instrument cannot deny payee's capacity to indorse the instrument to a holder in due course (Sec. 121):

No maker of a note and no acceptor of a bill payable to order shall be permitted to deny the payee's capacity at the date of the note or the bill to indorse the same.

No indorser of an instrument be permitted to deny the signature or capacity to contract of any prior party to the instrument (Sec. 122).

Liability of Parties to Negotiable Instruments

The liability of parties has been given in Sec. 30 to 32 and 35 to 42 which are as follows:

1. Liability of Drawer (Sec. 30):

The drawer of a bill or cheque is bound in case of dishonour by the acceptor or drawee thereof to compensate the holder, provided due notice of dishonour has been given to, or received by, the drawer.

2. Liability of drawee of a cheque (Sec.31):

The drawee of a cheque having sufficient funds of the drawer in his hands properly applicable to the payment of such cheque must pay the cheque when duly presented and in default of such payment, must compensate the drawer for any loss or damage caused by such fault.

It should be noted that this liability of the drawee is towards the drawer only. A holder of a cheque has no right to any compensation for any damage or loss suffered by him.

3. Liability of maker of note and acceptor of a bill (Sec. 32):

In the absence of a contract of the contrary, the maker of a note and the acceptor of a bill are bound to make the payment due on the instrument.

4. Liability of indorser (Sec. 35):

In the absence of a contract to the contrary, every indorser of a negotiable instrument before maturity is liable to every subsequent holder in case of dishonour of the instrument, provided due notice of dishonour has been given to, or received by such indorser. Every indorser, after dishonour, is liable as if the instrument is payable on demand.

5. Liability of prior parties (Sec. 36):

Every prior party to a negotiable instrument is liable thereon to a holder in due course until the instrument is duly satisfied.

6. Liability of maker, drawer, and acceptor as principal (Sec. 37):

The maker of a note or a cheque, the drawer of a bill of exchange until acceptance, and the acceptor, after acceptance, in the absence of a contract to the contrary, are respectively liable on the instrument as principal debtor.

7. Liability of other parties as surety (Sec. 37):

It is further provided that the other parties thereto are liable thereon as sureties for the maker, drawer or acceptor, as the case may be.

8. Liability of prior party in respect of each subsequent party:

Each of the above such surety is, in the absence of a contract to the contrary, also liable as a principal debtor in respect of each subsequent party.

Example:

A draws a bill payable to his own order on B. A, later on indorses the bill to C, C to D and D to E. As between E and B, B is the principal debtor, and A, C and D are sureties. As between A and C, C is the principal debtor and D is his surety.

9. Liability of agent (Sec. 28):

An agent who signs or indorses a negotiable instrument, without clearly signifying on it, that he is signing merely as an agent, will be personally liable on the instrument.

10. Liability of legal representative: As a rule, liability of the legal representative who signs a negotiable instrument is unlimited. However, he may, by express agreement, limit his liability.

11. Liability in case of contract of surety-ship (Sec. 39):

When the holder of an accepted bill of exchange enters into any contract with the acceptor, which under Sec. 134 or 135 of the Indian Contract Act, 1872, would discharge the other parties, the holder may expressly reserve his right to charge the other parties and in such case, they are not discharged.

12. Liability of acceptor when indorsement is forged (Sec. 41):

An acceptor of a bill of exchange already indorsed is not relieved from his liability by reason, that such indorsement is forged if he knew or had reason to believe the indorsement to be forged when he accepted the bill.

13. Liability for acceptance of bill drawn in fictitious name:

An acceptor cannot escape his liability on a fictitious bill.

14. Liability for instrument made, etc. without consideration:

A holder in due course is not affected by the absence of consideration on the part of the prior parties. As such, he can hold the transferor liable on the instrument.

Consideration in Case of Negotiable Instruments (Sees. 43-45):

As pointed out in the introductory chapter on Negotiable Instruments, one of the important presumptions in case of a negotiable instrument is that consideration by the law. The law presumes that every negotiable instrument was made or drawn, accepted, endorsed and negotiated for transfer of consideration. As such the holder need not prove consideration. However, this presumption would not arise if it is proved that the instrument was obtained from, its owner by an offence, fraud or for unlawful consideration.

1. Instruments obtained without consideration (Sec. 43):

The position is the same even when there is partial failure of consideration. Where a party obtains an instrument without consideration, it cannot claim the amount of the instrument. However, if a holder, in due course gets the instrument he acquires, a good title and any party claiming thereafter, also gets a good title as it is purged of its defects.

2. Partial absence or failure of consideration (Sec. 44):

The position is the same even when there is partial failure of consideration.

3. Partial failure of consideration not consisting of money (Sec.45):

Where a person has signed a promissory note, bill of exchange or cheque, although it was not payable in currency in circulation, yet it can easily by ascertained, and the same has failed partly, the drawee or holder can only recover the amount paid he cannot recover more than that. However, a holder in due course can recover the amount mentioned in the instrument and covered by the stamp affixed on the instrument.