Chapter 2

BANKING LAW AND PRACTICE

2.1 Legal Aspects of Banking- Overview of the Legislations affecting Banking—Banking

Regulation Act,
2.2 RBI Act,
2.3 Negotiable Instruments Act-Types of Negotiable Instruments-Characteristics of
Negotiable Instruments-Endorsements, Crossing of Cheques; Paying Banker, Collecting
Banker-Payment in due course, Garnishee Order.

2.1 Legal Aspects of Banking

Banking Regulation Act, 1949
The Banking Regulation Act, 1949 is one of the important legal frame works. Initially the
Act was passed as Banking Companies Act, 1949 and it was changed to Banking Regulation
Act 1949. Along with the Reserve Bank of India Act 1935, Banking Regulation Act 1949
provides a lot of guidelines to banks covering wide range of areas. Some of the important
provisions of the Banking Regulation Act 1949 are listed below. – The term banking is
defined as per Sec 5(i) (b), as acceptance of deposits of money from the public for the
purpose of lending and/or investment. Such deposits can be repayable on demand or
otherwise and withdraw able by means of cheque, drafts, order or otherwise – Sec 5(i)(c)
defines a banking company as any company which handles the business of banking – Sec
5(i)(f) distinguishes between the demand and time liabilities, as the liabilities which are
repayable on demand and time liabilities means which are not demand liabilities – Sec 5(i)(h)
deals with the meaning of secured loans or advances. Secured loan or advance granted on the
security of an asset, the market value of such an asset in not at any time less than the amount
of such loan or advances. Whereas unsecured loans are recognized as a loan or advance
which is not secured – Sec 6(1) deals with the definition of banking business – Sec 7
specifies banking companies doing banking business in India should use at least on work
bank, banking, banking company in its name – Banking Regulation Act through a number of
sections restricts or prohibits certain activities for a bank. For example: (i) Trading activities
of goods are restricted as per Section 8 (ii) Prohibitions: Banks are prohibited to hold any
immovable property subject to certain terms and conditions as per Section 9 . Further, a
banking company cannot create a charge upon any unpaid capital of the company as per
Section 14. Sec 14(A) stipulates that a banking company also cannot create a floating charge
on the undertaking or any property of the company without the prior permission of Reserve
Bank of India

2.2 AN OVERVIEW OF RBI ACT, 1934 AND BANKING REGULATION ACT 1949
Reserve Bank of India Act, 1934 The Reserve Bank of India Act, 1934 was enacted to
constitute the Reserve Bank of India with an objective to (a) regulate the issue of bank notes
(b) for keeping reserves to ensure stability in the monetary system (c) to operate effectively
the nation’s currency and credit system The RBI Act covers: (i) the constitution (ii) powers
(iii) functions of the Reserve Bank of India. The act does not directly deal with the regulation
of the banking system except for few sections like Sec 42 which relates to the maintenance of
CRR by banks and Sec 18 which deals with direct discount of bills of exchange and
promissory notes as part of rediscounting facilities to regulate the credit to the banking
system. The RBI Act deals with: (a) incorporation, capital, management and business of the
RBI (b) the functions of the RBI such as issue of bank notes, monetary control, banker to the
Central and State Governments and banks, lender of last resort and other functions (c) general
provisions in respect of reserve fund, credit funds, audit and accounts (d) issuing directives
and imposing penalties for violation of the provisions of the Act

2.3 Definition and Meaning of Negotiable Instruments:

Section 13 of the Indian Negotiable Instruments Act, 1881 defines a Negotiable Instrument as
“a promissory note, bill of exchange or cheque payable either to order or to the bearer”. This
definition merely states about the promissory note, bill of exchange or cheque, but does not
give the meaning of negotiable instruments.

A negotiable instrument can be defined as a document or instrument whose property (legal

right to money represented by it) can be transferred from one person to another by mere
delivery or by endorsement and delivery, and which gives a valid title to the bonafide holder
for value.
Characteristics of Negotiable Instruments
The chief characteristics of a negotiable instrument are:
1. Free Transferability
The basic characteristic of a negotiable instrument is that it is freely transferable from one
person to another. i.e., the ownership of the property in a negotiable instrument is freely
transferable. If it is a bearer instrument, it can be transferred by mere delivery. If it is an order
instrument, it can be transferred by endorsement and delivery.
2. Negotiability
Negotiability feature means that the bonafide transferee of a negotiable instrument (i.e. the
person who gets a negotiable instrument for value and in good faith and without the
knowledge of the defect in the title of the transferor) becomes a holder in due course, and gets
a better title than that of the transferor or any of the previous holders. The bonafide transferee
is not affected by the defect in the title of the transferor or any of the previous holders.
3. Right of action in his own name
The holder in due course of a negotiable instrument gets the right to sue upon the instrument
in his own name. In other words, the holder in due course of a negotiable instrument is
entitled to sue the transferor or any other person liable on the instrument in his own name
without giving him (i.e., the transferor or any other party liable on the instrument) any notice.
4. Presumptions
Certain presumptions apply to all negotiable instruments. Section 118 of the Negotiable
Instruments Act, 1881 provides that, unless the contrary is proved, the following
presumptions shall be made by the court as to a negotiable instrument:
➢ Every negotiable instrument was made, drawn, accepted, endorsed, negotiated or
transferred for consideration.
➢ Every negotiable instrument bearing a date was made or drawn on that date.
➢ Every accepted bill of exchange was accepted within a reasonable time after its date
and before its maturity.
➢ Every transfer of a negotiable instrument was made before its maturity.
➢ The endorsements appearing on the negotiable instrument were made in the order in
which they appear therein.
➢ A lost or destroyed negotiable instrument was duly stamped and the stamp was duly
cancelled.
 ➢ The holder of a negotiable instrument is a holder in due course.
h. In a suit upon a dishonored instrument, the court, on proof of protest, presumes
that it was dishonored unless this fact is disproved.

Types of Negotiable Instruments

Negotiable instruments can be broadly classified into two:
1. Instruments negotiable by law
2. Instruments negotiable by custom or usage of trade.
Instruments negotiable by custom or usage includes Government promissory notes, dividend
warrants, share warrants etc.

In India, law recognizes only three instruments as negotiable and they are:
1. Promissory Note
2. Bill of Exchange, and
3. Cheque

Promissory Note
Section 4 of the Negotiable Instruments Act defines a Promissory Note as “ 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”.
Thus, a promissory note contains a promise by the debtor to the creditor to pay a certain sum
of money after a certain date. Hence, it is always drawn by the debtor and he is called the
‘maker ’of the instrument.
Features of Promissory Note:
a. It is an instrument in writing.
b. It is a promise to pay.
c. The undertaking to pay is unconditional.
d. It should be signed by the maker.
e. The maker must be certain.
f. The payee must be certain.
g. The promise must be to pay money and money only.
h. The amount must be certain.
Bill of exchange
Section 5 of the Negotiable Instruments Act defines a bill of exchange as “ 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”.
Thus, a bill of exchange is a written acknowledgement of the debt, written by the creditor and
accepted by the debtor. There are usually three parties to a bill of exchange- drawer, drawee
or acceptor and payee. Drawer himself may be the payee.

The Drawer: The person who draws the bill.

The Drawee: The person on whom the bill is drawn.
The Acceptor: The person one who accepts the bill. Generally, the drawee is the acceptor but
a stranger may accept it on behalf of the drawee.
The payee: one to whom the sum stated in the bill is payable, either the drawer or any other
person may be the payee.
The holder: is either the original payee or any other person to whom, the payee has endorsed
the bill. In case of a bearer bill, the bearer is the holder.
Drawee in case of need: Besides the above parties. Another person called the “drawee in
case of need” may be introduced at the option of the drawer. The name of such a person may
be inserted either by the drawer or by any endorser in order that resort may be had to him in
case of need, i.e., when the bill is dishonored by either non-acceptance or non-payment.
Acceptor for honour: Further, any person may voluntarily become a party to a bill as
acceptor. A person, who on the refusal by the original drawee to accept the bill or to furnish
better security, when demanded by the notary, accept the bill supra protest in order to
safeguard the honour of the drawer or any endorser, is called the acceptor for honour.

Essential features:
a. It must be in writing.
b. It must be signed by the drawer.
c. The drawer, drawee and payee must be certain.
d. The sum payable must also be certain.
e. It should be properly stamped.
f. It must contain an express order to pay money and money only. g. The order must be
unconditional.

Holder and Holder in Due Course Holder of a Negotiable Instrument

In terms of Section 8 of the Negotiable Instruments Act:

‘The holder of a promissory note, bill of exchange or cheque means any person entitle in his
own name to the possession thereof and the receive or recover the amount due thereon from
the parties thereto’.

Thus, the holder of a negotiable instrument is the person who is legally entitled to recover the
amount from the parties of the instrument and who is in possession of the instruments. Here
the Indian law makes a slight departure from the English law. Under the Bills of exchange
Act, a holder means the payee or endorsee of a bill or note, who is in possession of it, or the
bearer thereof. In terms of this definition, the holder need not necessarily be a lawful holder.

For instance, the finder of a cheque duly endorsed so as to make it payable to bearer is a
holder. For instance the finder of a cheque duly endorsed so as to make it payable to bearer is
a holder. But according to the Negotiable Instruments Act, the holder must be entitled to
receive or recover the amount due thereon from the parties thereto. Therefore, a person who
has obtained possession of a negotiable instrument by theft or any other unlawful means is
not a holder.

Holder in Due Course of a Negotiable Instrument

Section 9 of the Negotiable Instruments Act defines a ‘holder in due course ’as:
‘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 endorsee
thereof if 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. ’
Thus, a ‘holder in due course ’is a person who:

1. Is in possession of the instrument as defined in Section 8;

2. Obtains possession of the instrument before maturity;
3. Obtains possession of the instrument for valuable consideration
(Valuable consideration in the case of a negotiable instrument is always presumed until the
contrary is proved) and
4. Is a holder, without having sufficient cause to believe that any defect existed in the title of
the person from whom he received his title?

Here again, the Negotiable Instruments Act differs slightly from the Bills of exchange Act,

According to Section 29 of the Bills of exchange Act:

‘A holder in due course is a holder who has taken a bill complete and regular on the face of it,
under the following conditions; namely:

(a) That he became the holder of it before it was overdue and without notice that it had been
previously dishonored, if such was the fact;
(b) That he took the bill in good faith and for value, and that at the time the bill was
negotiated to him he had no notice of any defect in the title of the person who negotiated it. ’

From the above definition, it can be seen that a person who takes an instrument in good faith
is a holder in due course, irrespective of whether or not he takes it negligently. In other
words, the fact that a person has not exercised great caution or has not been negligent is not
sufficient to dispute the title of the holder of a negotiable instrument, provided he has acted in
good faith. However, according to Indian law, a person is a holder in due course only if he
takes the instrument without having sufficient cause to believe that any defect existed in the
title of the person from whom he received his title. Thus, according to the Negotiable
Instruments Act person is expected to take an instrument with reasonable care and without
negligence.

A holder in due course obtains absolute title, even if he takes the instrument from a thief. All
the previous parties to the instrument are liable to him. An exception to this general rule may
be found when the instrument bears a forged signature of the true owner. Thus transferee of
such an instrument does not get a valid title except in the case of estoppels.

Cheques
Section 6 of the Act defines a cheque as “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”.
Thus, a cheque is an instrument in writing, containing an unconditional order, drawn on a
specified banker, signed by the drawer, directing the banker, to pay, on demand, a certain
sum of money only, to a certain person or to his order or to the bearer of the instrument.
Essentials of a cheque:
1. A cheque must be in writing. oral orders do not constitute a cheque. But, the law has
not specified the writing materials with which a cheque has to be written.

2. It must contain an order. This implies that the cheque must contain an order to pay, and
not a request to pay.

3. The order to pay must be unconditional. No condition should be attached to the order.
In other words, the banker should not be ordered to do anything else except to pay the
money.

4. It must be drawn on a banker. It cannot be drawn on any other person, except on the
banker.

5. It must be drawn on a specified banker. It cannot be drawn on any bank, but only on
the particular bank where the drawer has an account.

6. It must be drawn only by the customer of the bank, i.e. only by the account holder.

7. It must be signed by the drawer (i.e., the account holder) or his authorized holder.
Rubber stamp signature is not accepted by the bankers, though it is legally permissible.
 8. The order must be for the payment of money only. The order must direct the banker to
pay only money and not any other thing.

9. The order must be for the payment of certain sum of money. The amount of money
ordered to be paid must be certain.

10. The amount must not be expressed to be payable otherwise than on demand.

11. The amount of the cheque must be made payable to a certain person or to his order or
to the bearer of the cheque.

Kinds of Cheques:
Cheques can be classified into two categories. They are:
1. Bearer Cheques
A bearer cheque is one which is payable to the bearer or the possessor. In case of these
Cheques, the payee need not be named. It can be transferred to others by mere delivery
without any endorsement.

2. Order Cheques
An order cheque is a cheque which is payable to a certain person or to his order. It can be
transferred to another person through endorsement and delivery.

Crossing of Cheques
Need
Very often, an open or uncrossed cheque payable across the counter of the paying banker
lends to fraud by unscrupulous persons and causes loss either to the customer or to the
banker. In order to avoid such a risk and to protect the true owner of the cheque and the
banker, the system of crossing of Cheques has been introduced.
Meaning
Crossing of a cheque means drawing across the face of the cheque two parallel transverse
lines with or without the words “And Company” or “Not Negotiable” or “Account Payee”
between the parallel transverse lines. It can be hand-written or stamped.
Object of Crossing
Crossing affords security and protection to the true owner, since payment of such a cheque
has to be made through a banker. It facilitates the tracing of the person who has received the
payment of the cheque. This traceability ensures the safety of the cheque.

Who can Cross a Cheque?

1. The drawer of a cheque can cross it at the time of issuing it.
2. Any holder can cross an uncrossed cheque.
3. The banker in whose favor a cheque has been crossed can again
Cross it in favor of another banker for the purpose of collection.

Types of Crossing:
There are two types of crossing viz.
1. General Crossing
Section 123 of the Act, defines a general crossing as “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”
So, general crossing means drawing across the face of a cheque two parallel transverse lines
with or without the words “And Company” or “Not Negotiable” or “Account Payee” between
the parallel transverse lines.
Essential features:
a. There must be two parallel transverse lines.
b. The two parallel transverse lines must be on the face of the cheque.
c. The lines are generally drawn on the left hand side.
d. The words “and company” or its abbreviation “and co.” or “& Co” do not form a necessary
part of the general crossing.
e. Words, such as “Not Negotiable” or “Account Payee” also do not form an essential part of
the general crossing.

The paying banker is required to pay the amount of a generally

Crossed cheque to another banker, but not to the holder at the counter
Special Crossing
Section 124 of the Act defines a special crossing as “where a cheque bears across its face an
addition of the name of a banker 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”. So, special crossing means writing across the face of a cheque the
name of some banker with or without lines or words such as “Not Negotiable” or “Account
Payee”.

Essential features:
a. Two parallel transverse lines are not required.
b. The name of the collecting banker must be necessarily specified across the face of the
cheque, this itself constitutes special crossing.
c. Words such as “Not Negotiable” or “Account Payee” also do not form a necessary part of
special crossing.
d. The paying banker is required to pay the amount of a specially crossed cheque only to the
banker named in the cheque or his agent for collection.
e. It makes a cheque safer than general crossing. Not Negotiable Crossing

The words “Not Negotiable” may be included in a general or a special crossing. When a
cheque is crossed generally or specially with the words “Not Negotiable”, it loses its special
feature of negotiability. As a result, such a cheque cannot give to the transferee or the holder
a better title than that of the transferor or the person from whom the transferee received it.
But it does not restrict the transferability of a cheque and does not affect either the paying or
the collecting banker.

Account Payee Crossing

The words, “Account Payee” may be included in a general or special crossing. These words
have no statutory recognition. They are used because of banking practice. It is a warning to
the collecting banker that he should collect only for the benefit of the payee. If the collecting
banker collects such a cheque for a party other than the payee, he will be liable to the true
owner of the cheque under the doctrine of conversion. This type of crossing does not affect
the paying banker. When a cheque is crossed generally or especially with the words “Not
Negotiable” or “Account Payee”, it will possess the features of both “Not Negotiable”
crossing and “Account Payee” crossing.

Double Crossing
Double crossing means crossing a cheque especially to more than one banker. A cheque
cannot have double or two crossings, because the very purpose of the first special crossing is
defeated by the second special crossing. The paying banker should refuse to honor such a
cheque as it is prohibited under the Act. However, the collecting banker need not refuse to
collect such a cheque.
Though a cheque cannot have two special crossings, an exception to this rule has been made
for the purpose of collection. By the virtue of this exception, the banker to whom a cheque is
crossed specially may, either because he does not have a branch at the place of the paying
banker, or because of some other reason, cross it especially to another banker who acts as his
agent for the purpose of collection. But, in such a case, the second special crossing must
specify that the banker to whom the cheque has been specially crossed again acts as the agent
of the first banker for the purpose of the collection of the cheque.

Cancelling or opening of crossing

Opening of crossing means cancelling the crossing found on a cheque. The law is silent on
the opening of the cheque. But banking custom permits the opening of the cheque.
The crossing is, generally, opened at the request of the payee or the holder who does not have
a bank account. When the crossing is cancelled, the cheque becomes an open cheque or
uncrossed cheque and becomes payable at the counter of the paying banker.
The crossing can be cancelled only by the drawer by striking off the crossing, writing the
words “crossing cancelled, pay cash”, and putting his full signature near the crossing. While
paying such opened cheque, the paying banker should verify the genuineness of the drawer’s
signature confirming the cancellation of the crossing. If the signature is forged and the paying
banker makes the payment then, he becomes liable to the true owner of the cheque.

Marking of Cheque
‘Marking ’means giving a certificate by the banker to a cheque that it is good for payment.
This takes place when a payee has any doubt of the cheque being honored and not knowing
the whereabouts of the drawer. Under such circumstances, the paying banker may be
approached for ‘marking’. The paying banker may or may not oblige in such a situation. His
refusal to mark the cheque does not amount to wrongful dishonor of the cheque and does not
incur any sort of liability.
The paying banker, when he simply puts his initial on the cheque or writes the words ‘marked
good for payment ’and puts his initial, the cheque becomes a marked cheque.
The effects of marking are:
1. The drawer has drawn the cheque in good faith.
2. Sufficient funds are available to pay the cheque.
3. It adds to the credit of the drawer and the credit of the paying banker.
The legal aspects of a marked cheque depend upon the circumstances under which it is
marked. Whether it is marked for a drawer or for a payee or the collecting banker or the
holder has to be taken note of.
1. Marking for drawer: The drawer may request the banker to mark the cheque to satisfy the
payee. If the banker marks the cheque, it amounts to constructive payment. This means the
banker cannot dishonor the marked cheque inspire of the death, lunacy or insolvency of the
drawer or even when the garnishee order is against that account. The banker has to earmark
the funds for the payment of the marked cheque and the drawer has no right to countermand
the payment of such cheque.
2. Marking for holder or payee: The banker can also mark the cheque at the instance of the
payee or holder. But such marking does not impose on the paying banker any legal
obligation. Marking in this case simply signifies that there is sufficient amount to meet the
cheque at the time of marking. But the banker need not appropriate funds to meet the
obligation of that cheque when it is presented for payment. It only signifies that the cheque is
drawn in good faith.

3. Marking for a collecting banker: When a customer’s cheque is presented by the

collecting banker after the clearing hours, the paying banker can mark the cheque at the
request of the collecting banker. This is done to protect the interest of the customers. When
such Cheques are marked, the paying banker should honor the cheque at a later stage. In
order to meet such obligation, he appropriates funds from the drawer’s account. The drawer
cannot countermand the payment of such marked Cheques. Such marking is construed as an
undertaking to pay the value of cheque and will be considered as a ‘constructive payment’.
Material Alterations:
A material alteration is an alteration which alters (i.e., changes) materially or substantially the
operation of a cheque, and thereby, the rights and liabilities of the parties thereto. Such
alterations will be material alteration, whether it is beneficial or detrimental to any party to
the instrument.
Examples:
1. Alteration of the date or sum payable or place of payment or the name of the payee.
2. Changing an order cheque into a bearer cheque.
3. Cancelling the crossing on a cheque.
4. Changing a specially crossed cheque into a generally crossed cheque.
5. Striking off the words “Not Negotiable” or “Account Payee” from a general or special
crossing.

There are certain alterations which cannot be regarded as material alterations. For example:
1. Changing a bearer cheque into an order cheque.
2. Changing an open or uncrossed cheque into a crossed cheque.
3. Changing a generally crossed cheque into a specially crossed cheque.
4. Adding the words “Not Negotiable” or “Account Payee” to a general or to a special
crossing.
5. Completing an inchoate (i.e., an incomplete) cheque by filling up the blanks.

Effects of Material Alteration:

A cheque which contains a material alteration cannot be regarded as a cheque. However, such
a cheque becomes valid, if the material alteration is confirmed by the drawer under his full
signature. When the material alteration is apparent and is presented for payment to the paying
banker, he should see whether it is confirmed by the drawer or not. If it is confirmed then he
can pay such a cheque without any risk. If such alteration is not confirmed then he should
return the cheque unpaid with remark for the same.

If the material alteration is not apparent or is very difficult to detect even on a careful
examination and consequently, the payment is made without the drawer’s confirmation, the
paying banker is protected, provided the payment is made in due course.