Special Contracts

Dr. V.K. Unni

Public Policy & Management Group
Indian Institute of Management Calcutta
E-mail: unniv@iimcal.ac.in / krisunni1@gmail.com
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Special Contracts
In India, the Law of Contracts is contained in the Indian Contract
Act,1872.
The Act lays down the general principles relating to formation,
performance and enforceability of contracts and the rules relating to
certain special types of contracts like Indemnity and Guarantee;
Bailment and Pledge, and Agency.
The Partnership Act; the Sale of Goods Act; the Negotiable
Instruments Act; though technically belonging to the Law of
Contracts, have been covered by separate enactments
Indemnity
A contract by which one party promise to save the other from loss
caused to him by the conduct of the promisor himself or by the
conduct of any other person is a Contract of Indemnity"

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Special Contracts
X contracts to indemnify Y against the consequences of any
proceedings which Z may take against Y in respect of a certain
sum This is a contract of Indemnity.
The definition provides the following essential elements There must be a loss
The loss must be caused either by the promisor or by any other
person.
Indemnifier is liable only for the loss.

Thus, it is clear that this contract is contingent in nature and is

enforceable only when the loss occurs

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Special Contracts
Rights of the indemnity holder
The promisee (Indemnity holder) in a contract of indemnity, acting
within the scope of his authority, is entitled to recover from the
promisor
All damages that he is compelled to pay in a suit in respect of any
matter to which the promise of indemnity applies.
All costs that he is compelled to pay in any such suit
All sums which he may have paid under the terms of a
compromise in any such suite
Disadvantages of Indemnity
An indemnity holder cannot hold the indemnifier liable until he
has suffered an actual loss.
This is a great disadvantage to the indemnity holder in cases
where the loss is imminent and he is not in the position to bear the
loss

Special Contracts
Contract of Guarantee
A contract of guarantee is a contract to perform the promise, or
to discharge the liabilities of a third person in case of his default.
The person who gives the guarantee is called Surety, the person
in respect of whose default the guarantee is given is called
Principal Debtor, and the person to whom the guarantee is
given is called Creditor.
A Guarantee may be either oral or written."

Illustration: X promises to a shopkeeper Y that X will pay for

the items being bought by Z if Z does not pay, this is a contract
of guarantee. In this case, if Z fails to pay, Y can sue X to
recover the balance.
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Special Contracts

1.

2.

A contract of guarantee has the following essential elements

Principal Debtor - The main function of a guarantee is to help a
credit-unworthy person to get a loan or financial assistance
Thus, there must exist a principal debtor for a recoverable debt
for which the surety is liable in case of the default of the
principal debtor.
Consideration - As with any valid contract, the contract of
guarantee also must have a consideration.
The consideration in such contract is anything done or the
promise to do something for the benefit of the principal debtor
In general, if the principal debtor is benefited as a result of the
guarantee, it is sufficient consideration for the sustenance of the
guarantee.
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Special Contracts
A guarantee obtained by misrepresenting facts that are
material to the agreement is invalid,

Similarly a guarantee obtained by concealing a material fact

is invalid as well
Continuing Guarantee

A guarantee which extends to a series of transactions is

called a continuing guarantee.

A continuing guarantee can be revoked at any time by the

surety by notice to the creditor.

Once the guarantee is revoked, the surety is not liable for

any future transaction however he is liable for all the
transactions that happened before the notice was given.
3.

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Special Contracts
Rights of the Surety
Guarantee being a contract, all rights that are available to the
parties of a contract are available to a surety as well.
The following are the rights specific to a contract of
guarantee that are available to the surety.
Rights against principal debtor
1. Right of Subrogation : Where a guaranteed debt has become
due, the surety upon payment is invested with all the rights
which the creditor had against the principal debtor.
This means that the surety steps into the shoes of the creditor
Whatever rights the creditor had, are now available to the
surety after paying the debt.
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Special Contracts
Right to get Indemnified

In every contract of guarantee there is an implied promise by

the principal debtor to indemnify the surety; and the surety
is entitled to recover from the principal debtor whatever sum
he has rightfully paid under the guarantee
Rights against creditor

Right to securities : Surety is entitled to the benefit of every

security which the creditor has against the principal debtor at
the time when the contract of guarantee is entered into

If the creditor loses or without the consent of the surety parts

with such security, the surety is discharged to the extent of
the value of the security.
2.

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Special Contracts
Right of set off : If the creditor sues the surety, the surety may have
the benefit of the set off, if any, that the principal debtor had against
the creditor.
He is entitled to use the defences that the principal debtor has against
the creditor.
Thus if the creditor owes the principal debtor something, for which
the principal debtor could have counter claimed, then the surety can
also put up that counter claim.
Discharge of Surety
A surety is said to be discharged from liability when his liability
comes to an end.
A variance made without the consent of the surety in terms of the
contract between the principal debtor and the creditor, discharges the
surety as to the transactions after the variance.

Special Contracts
The surety is discharged by any contract between the creditor and
the principal debtor by which the principal debtor is discharged;
The liability of a surety is co-extensive with that of the principal
debtor, unless it is otherwise provided in the contract.
Main Differences between Indemnity and Guarantee
In a contract of indemnity there are two parties i.e. indemnifier and
indemnified. A contract of guarantee involves three parties i.e.
creditor, principal debtor and surety.
An indemnity is for reimbursement of a loss, while a guarantee is
for security of the creditor.
In a contract of indemnity the liability of the indemnifier is primary
and arises when the contingent event occurs. In case of contract of
guarantee the liability of surety is secondary and arises when the
principal debtor defaults.
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Special Contracts
The indemnifier after performing his part of the promise has no
rights against the third party, whereas in a contract of
guarantee, the surety steps into the shoes of the creditor on
discharge of his liability, and may sue the principal debtor
Guarantees and Debt Instruments by Corporates
It is very common in a business transaction to support a loan
with a bank guarantee
However in 2009 RBI had to intervene with a regulation
which had the effect of banning banks from issuing guarantees
in the case of corporate debt instruments like debentures
This essentially followed SBIs guarantee to Tata Motors Rs
4,200 crore non-convertible debentures (NCDs) in May 2009

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Special Contracts

Theoretically these NCDs could be bought by foreign funds and

if that happens the SBI guarantee will mean that a bank is
indirectly guaranteeing a foreign investment
RBI wants to avoid a situation where Banks may go out of
control by issuing such guarantees which could result in a
higher exposure than their net worth, similar to the case of
American International Group (AIG) in the US
As result of SBI's guarantee of timely payment of dues to the
institutional investors, the Tata Motors bond issue obtained a
higher rating from credit rating agencies, which in turn ensured
lower interest rates.
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UB Holdings Guarantee of Kingfisher Loans

United Breweries Holdings, a Vijay Mallya Group's holding

company with stakes in United Spirits, has guaranteed about Rs
6,000 crore of nearly Rs 7,000 crore loans of Kingfisher Airlines
Although there is very little in terms of assets recoverable from
Kingfisher Airlines, the guarantee of UB Holdings could be used to
enforce lenders' claim.
The value of shares held by UB Holdings in listed companies is
valued at more than Rs 5,200 crore
Very recently (20/12/2013) the Karnataka High Court held as null
and void the share transfer made by UB holdings in United Spirits
to the British company Diageo in response to a petition by the
creditors (banks)
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Special Contracts
Bailment and Pledge
A 'bailment' involves the delivery of goods by one
person to another for some purpose upon a contract
that they shall, when the purpose is accomplished be
returned or disposed of according to the directions of
the person delivering them.
The person delivering the goods is called the 'bailor'
and the person to whom the goods are delivered is
called the 'bailee'.
The examples of a contract of bailment are:-leaving
luggage in a cloak room; leaving garments with a
tailor etc.
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Special Contracts
The important feature of bailment is the transfer of possession.
The ownership remains with the owner and there cannot be a
bailment of immovable property like land.
Pledge
A 'pledge' involves a bailment of goods where the goods are
delivered as a security for payment of a debt or performance of a
promise.
The bailor is called the 'pledgor' or 'pawnor' and the bailee is called
the 'pledgee' or 'pawnee'.
Thus, pledge is a special kind of bailment and can be made only of
movable properties.
In order to make the pledge legally valid it is essential that the
pledgor has the legal right/title to retain the goods.

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Special Contracts
Main Differences between Bailment and Pledge
Purpose:- A pledge is made for a specific purpose (to raise a
loan), while bailment can be made for any purpose
Property:- In bailment, the bailee gets only the possession of
goods bailed and the ownership remains with the bailor.
In the case of pledge, the pledgee acquires a special property
in the goods pledged whereby he gets possession coupled
with the power of sale, on default.
Right of sale :- Bailee can exercise a lien on the goods bailed
and he has no right of sale (lien means the right to retain
possession)
But in case of a pledge, the pledgee can sell the goods after
due notice to pledgor.
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Special Contracts
Contract of Agency
Agency is a special type of contract.
The principles of contract of agency are
1. Except matters of a personal nature, what all things a person can do
himself can also be done through agent
2. A person acting through an agent is acting himself, i.e. act of agent is
act of Principal. - Since agency is a contract, all general requirements of a valid
contract are applicable to agency contract also
One important distinction is that no consideration is necessary to
create an agency.
An agent is a person employed to do any act for another or to
represent another in dealings with third persons.
The person for whom such act is done, or who is so represented, is
called the principal

Special Contracts
Any person who is of the age of majority and who is of sound mind,
may employ an agent.
As between the principal and third persons any person may become
an agent, but no person who is not of the age of majority and of
sound mind can become an agent, so as to be responsible to his
principal
An agent can act on behalf of Principal and can bind the Principal.
Agents main duties to Principal
Conducting principals business as per his directions
Carry out work with normal skill and diligence
Render proper accounts
Agents duty to communicate with principal
Agents duty to pay sums received for principal

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Special Contracts
Main Powers of Principal
Recover damages from agent if he disregards directions of Principal
Obtain accounts from Agent
Recover moneys collected by Agent on behalf of Principal
Main Duties of Principal
Pay remuneration to agent if it is agreed
Indemnify agent for lawful acts done by him as agent
Indemnify Agent for all acts done by him in good faith
Indemnify agent if he suffers loss due to neglect or lack of skill of
Principal.

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Special Contracts
Termination of Agency
An agency is terminated by
1. the principal revoking his authority; or
2. by the agent renouncing the business of the agency or;
3. by the business of the agency being completed; or
4. by either the principal or agent dying or principal becoming a
person of unsound mind; or
5. by the principal being adjudicated an insolvent

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Special Contracts
Sale of Goods
Sale of Goods is one of the special types of Contract and
initially this was part of Indian Contract Act itself
Later on a separate Sale of Goods Act was passed in 1930.
The Sale of Goods Act is complimentary to Contract Act.
Fundamental provisions of Contract Act apply to contract of
Sale of Goods also.
Thus provisions dealing with offer and acceptance, legally
enforceable agreement, mutual consent, parties competent to
contract, free consent, lawful object, consideration etc. apply
to contract of Sale of Goods also.
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Special Contracts

A contract of sale of goods is a contract whereby the seller transfers

or agrees to transfer the property in goods to the buyer for a price.
A contract of sale may be absolute or conditional.
A contract of sale may be made in writing or by word of mouth, or
partly in writing and partly by word of mouth or may be implied
from the conduct of the parties
Two parties are required for contract are the Buyer who buys or
agrees to buy goods and Seller who sells or agrees to sell goods
Where under a contract of sale the property in the goods is
transferred from the seller to the buyer, the contract is called a sale,
but where the transfer of the property in the goods is to take place at
a future time the contract is called an agreement to sell
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Special Contracts
Goods means every kind of movable property other than
actionable claims and money; and includes stock and shares,
growing crops, grass, and things attached to or forming part of the
land which are agreed to be severed before sale or under the contract
of sale.
Conditions and Warranties
Stipulation in a contract of sale with reference to goods which are the
subject thereof may be a condition or a warranty.
A condition is a stipulation essential to the main purpose of the
contract, the breach of which gives rise to a right to treat the contract
as cancelled.
A warranty is a stipulation collateral to the main purpose of the
contract, the breach of which gives rise to a claim for damages but
not to a right to reject the goods and treat the contract as cancelled

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Special Contracts

Caveat Emptor - The principle termed as caveat emptor means

buyer be aware.
Generally, buyer is expected to be careful while purchasing the
goods and seller is not liable for any defects in goods sold by him.
However with the evolution of Consumer Protection Laws this
concept is becoming outdated
Delivery of goods to buyer : Delivery of the goods and payment of
the price are concurrent conditions, unless otherwise agreed
This means that the seller shall be ready and willing to give
possession of the goods to the buyer in exchange for the price, and
the buyer shall be ready and willing to pay the price in exchange for
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possession of the goods.

Sale of Software ????

Software Licences
Software is never sold as any other product; it is
always viewed as an intangible property.
It is only licensed and this is the most popular form
of agreement being made in relation to software.
Under this agreement the person who develops the
software, licenses certain rights in relation to the
software to the user.
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Sale of Software ????

What these contracts normally grant is a non-exclusive and

non-transferable licence to run the software on a single
computer at a time.
The licensee is not in any way empowered to transfer this
right to any third party.
Since the licence is non-exclusive in nature the Licensor can
grant these rights to other parties.
The Licensee has the limited right to use the software only on
one computer at a given time
If anybody loads the same software into his computer by
making a copy from the Licensee then the Licensee is deemed
to have violated the Licence agreement.
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Sale of Software ????

Shrink Wrap Agreements
It is a sub category of software licences which intend to establish a
binding legal agreement between the software vendor and the user.
The agreement can be generally seen inside the box containing the
software, printed on the envelope containing the CD-ROM or disks,
or may be printed in the user manual.
There is a warning to the user not to open the software envelope or
use the software unless and until he or she fully agrees with the terms
and conditions of the agreement.
Shrink-wrap licences have traditionally been widely used in the
computer software industry in mass market transactions
Interestingly the word "shrink-wrap" has been linked to the fact that
such agreements used to be included on the outside of the software
packaging, which was visible through the clear plastic shrink-wrap
which was used to seal the package.

Special Contracts
Partnership
Partnership is one of the special types of Contract and earlier this was
part of Indian Contract Act itself but later converted into separate Act
in 1932.
The Indian Partnership Act is complimentary to Contract Act.
Basic provisions of Contract Act apply to contract of partnership
also.
Basic requirements of contract i.e. legally enforceable agreement,
mutual consent, parties competent to contract, free consent, lawful
object, consideration etc. apply to partnership contract
One crucial disadvantage of partnership is the unlimited liability of
partners for the debts and liabilities of the firm.
Any partner can bind the firm and the firm is liable for all liabilities
incurred by any firm on behalf of the firm.

Special Contracts

Partnership Firm is not a legal entity though it has limited identity

for purpose of tax law.
Partnership is the relation between persons who have agreed to
share the profits of a business carried on by all or any one of them
acting for all.
It is not a distinct legal entity apart from the partners Constituting it
Each partner is agent of all the remaining partners and thus
partners are mutual agents.
As per normal provision of contract, a partnership agreement can
be either oral or written.
However an Agreement in writing is necessary to get the firm
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registered.

Special Contracts
The partners must come together to share profits and the share need
not be in proportion to funds contributed by each partner.
Even though sharing of profit is essential, sharing of losses is not an
essential condition for partnership
Since partnership is an agreement there must be minimum two
partners.
In case of partnership, the number of members must not exceed 100,
however this cap of 100 is not applicable if it is formed by
professionals who are governed by special Acts (e.g. Chartered
Accountants, Lawyers etc)
Dissolution of a firm can be a) By agreement ,
b) Compulsory dissolution in case of insolvency
c) Dissolution on happening of certain contingency
d) By notice
e) Dissolution by Court

Special Contracts
Limited Liability Partnership
The concept of limited liability partnership (LLP) has been
introduced in India by the Limited Liability Partnership Act 2008,
which came into force from April 1, 2009
LLP tries to combine the advantages of ease of running a Partnership
and separate legal entity status and limited liability aspect of a
Company.
LLP is a separate legal entity separate from its partners, can own
assets in its name, sue and be sued.
Unlike corporate shareholders, the partners have the right to manage
the business directly
One partner is not responsible or liable for another partners
misconduct or negligence.
Compulsory registration to be done with Registrar of Companies
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LLP

Minimum of 2 partners and no maximum cap on the number

of partners.
Eligibility conditions for being a partner: Any individual or
body corporate may be a partner in a LLP. However an
individual shall not be capable of becoming a partner of a
LLP, if
(a) he has been found to be of unsound mind by a Court of
competent jurisdiction and the finding is in force;
(b) he is an undischarged insolvent; or
(c) he has applied to be adjudicated as an insolvent and his
application is pending.
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LLP

LLP has introduced the concept of Designated Partners

As per the law appointment of at least two Designated Partners
shall be mandatory for all LLPs.
Designated Partners shall be accountable for regulatory and legal
compliances, besides their liability as partners, per-se
Every LLP shall be required to have at least two Designated Partners
who shall be individuals and at least one of the Designated Partner
shall be a resident of India.
The role of Designated Partners in case of LLP is on same footage as
of Directors in case of Company.
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Special Contracts

LLP has perpetual succession.

The rights and duties of partners in LLP, will be decided by the
agreement between partners
The duties and obligations of Designated Partners shall be as
provided in the law.
Liability of the partners is limited to the extent of his contribution in
the LLP.
Every partner of an LLP would be, for the purpose of the business of
the LLP, an agent of the LLP but not of the other partners
No exposure of personal assets of the partner, except in cases of
fraud.
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Special Contracts

Both LLP and person, who own it, are separate entities and both
functions separately.
Liability for repayment of debts and lawsuits incurred by the LLP
lies on it and not the owner.
A LLP as legal entity is capable of owning its funds and other
properties, the LLP is the real person in which all the property is
vested and by which it is controlled, managed and disposed off.
The LLP Act contains enabling provisions pursuant to which a firm
(set up under Indian Partnership Act, 1932) and private company or
unlisted public company (incorporated under Companies Act) would
be able to convert themselves into LLPs
However converting an LLP into a company would not be allowed

Special Contracts
Negotiable Instruments Act 1881
Negotiable instruments play a very vital role in modern day
transactions
These are the principal instruments for making payments and
discharging various obligations
To be simple a negotiable instrument is a transferable
document which satisfies certain terms and conditions
Since they are transferable, they pass on freely from hand to
hand and thereby form an essential part of modern day
commercial transactions
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Special Contracts

The relevant Indian Law dealing with these instruments is the

Negotiable Instruments Act, 1881
However the Act refrains from defining a negotiable instrument
instead it only states that a negotiable instrument means a
promissory note, bill of exchange or cheque payable either to
order or bearer (Sec 13)
In other words the Act does not define a negotiable instrument,
it only clarifies that cheque, bills of exchange and promissory
notes are negotiable instruments
The most important feature is the good title it confers on the
person who receives it bona fide and for value, even if the
transferor had defective title to the said instrument
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Special Contracts
Essential features of negotiable instruments
Negotiable instruments are easily transferable from person to person
and the ownership of the property in the instrument is passed on by
mere delivery, if it is bearer instrument,
In the cases of order instruments, property in the instrument is passed
on by endorsement and delivery
Transferability is an essential feature of a negotiable instrument
A negotiable instrument confers absolute and good title on the
transferee, who takes it in good faith, for value and without notice
of the transferors defective title on the said instrument
Illustration X sells his mobile phone to Y, who makes the payment
through a bearer cheque. Even if Y has stolen this cheque from Z,
still X will get good title over the said cheque if he has exercised
reasonable care at the time of taking the cheque.
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Special Contracts
Thus a negotiable instrument is an exception to the
general rule that the transferor cannot transfer title
better than what he himself possesses
Promissory note
Promissory note is an instrument in writing which
contains an unconditional promise signed by the
maker to pay a certain sum of money only to a certain
person or to the order of certain person or to the
bearer of the instrument (Sec 4, N.I. Act 1881)

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Special Contracts
Bill of Exchange
It is an instrument in writing which contains an unconditional
order signed by the maker, directing a certain person to pay a
certain sum of money only to a certain person or to the order
of certain person or to the bearer of the instrument (Sec 5, N.I
Act 1881)
Generally this is in the form of an order from the creditor to
the debtor to pay a certain sum of money to a person specified.
The maker of the bill is called the drawer, person who is
directed to pay is called the drawee and the person who is
entitled to receive payment is called the payee
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Special Contracts
In many occasions the drawer can be the payee also
Cheque
Cheque is a bill of exchange drawn on a specified
banker and not expressed to be payable otherwise
than on demand
Thus in the case of a cheque the drawee is always a
banker and a cheque is only payable upon demand
Whereas other bills of exchange are payable after a
period of time specified therein, in the case of cheque
it is payable only after a demand is made

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Special Contracts
Similarities/ Dissimilarities between Promissory note, Bills
of Exchanges and Cheques
The law makes it clear that all these instruments should be in
writing
A cheque and a bill of exchange contain an order to the drawee
to pay the money whereas the promissory note there is an
undertaking by the maker to pay his creditor
Thus in the case of cheque and a bill of exchange the drawer
makes an unconditional order on another person to pay the
money, while in the case of the promissory note the drawer
himself promises to pay
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Special Contracts

However one common feature in the case of Promissory note,

Bills of Exchanges and Cheques is that the promise or order
should be an unconditional one
The main difference between a cheque and a bill of exchange
is that a cheque is always drawn on and is payable by the
banker, while a bill may be drawn on any person firm or
company
Thus only a customer of a bank having an account is entitled
to draw a cheque on the banker, with the same branch of the
bank where he has an account
A bill of exchange is generally drawn by the seller on his
customer or a creditor on his debtor
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Special Contracts
In the case of a promissory note, bill of exchange and a

cheque another similarity is that the amount of money to be

paid must be certain and should be specified clearly
Promissory notes, bill of exchanges and a cheques must be
payable either to order or to bearer
Time of payment: A cheque is always payable on demand
while in the case of a bill of exchange and promissory note it
must be payable after a period of time specified in the
instrument

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Special Contracts

A negotiable instrument is valid only if it bears the signature

of the drawer/promisor
In the case of a cheque, signature of the drawer must tally with
the specimen signature given to the bank at the time of
opening of account
In the case of a promissory note, bill of exchange they must be
stamped while in the case of a cheque this is not required
The valuation depends upon the value of the note or bill
If it is not stamped it cannot be admitted in evidence in case of
any disputes

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Special Contracts

Another similarity in the case of promissory note, bill of

exchange and a cheque is that the holder of these instruments
has the right to sue in his own name for the recovery of the
amount mentioned in it
All negotiable instruments are transferable from one person to
another
Thus the negotiable instrument confers upon the person who
acquired it bona fide and for value good title to the instrument,
in spite of any defect in the transferor's title
Such a person is called a holder in due course and he gets title
against the entire world
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Special Contracts
Concept of Negotiability
Illustration : Assume that A has sold his laptop to B
for Rs 40,000/- on three months credit.
In order to ensure that B will pay the money after
three months, A may write an order addressed to B
that he has to pay after three months, for value of
goods received by him, (i.e.Rs.40,000/) to A or
anyone holding the order and presenting it before
him (B) for payment.

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Special Contracts

This order which A writes is called a Bill of Exchange, A

is the Drawer, B is the Drawee,
This written document has to be signed by B to show his
acceptance of the order, then B becomes the acceptor
Thus A can hold the document with him for three months
and on the due date can collect the money from B or A
can use the document for meeting different business
transactions
Thus after a few days if A wants he can borrow money
from C for a period of 2 months and pass on this
document to C.
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Special Contracts

For transferring the Bill of Exchange to C, A just has to write on

the back of the document an instruction to pay money to C, and
sign it.
After doing so A has to deliver the Bill of Exchange to C
The above said act of signing on the back of the document is
called endorsement, A is the endorser and C is the endorsee
Now C becomes the owner of this document and he can claim
money from B on the due date.
In the alternative, C can further pass on the document to D after
instructing and signing on the back of the document.
This passing on process may continue further till the final
payment is made
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Special Contracts
The ease at which the property in a document transfers from one
person to another signifies the negotiability of the instrument.
This very often happens in the case of a cheque also
if A issues a ICICI Bank cheque worth Rs. 5,000/ in favour of B,
then B can claim Rs. 5,000/- from ICICI Bank, (A-Drawer, ICICIDrawee, B-Payee) or
B can transfer it to C to meet any obligation, like paying back a loan
that he might have taken from C. (B-Endorser, C-Endorsee)
Once B transfers it, C gets a right to Rs. 5,000/- and C can transfer it
to D if needed.
Such transfers may continue till the payment is finally made to
somebody.

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Special Contracts
Dr. V.K. Unni
Public Policy & Management Group
Indian Institute of Management Calcutta
E-mail: unniv@iimcal.ac.in

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