Post-dated Cheques: Security or Burden?

A little less than a month before he was sworn in as the new Chief Justice of India, Justice D. Y. Chandrachud along with Justice Hima Kohli ruled on a case of particular interest. The judgement in said case was sufficiently reported in news media and yet the wider implications of the judgement seem to have flown under the radar.

Facts of the Case

The case in question was Dashrathbhai Trikambhai Patel v. Hitesh Mahendrabhai Patel and Anr¹. A summary (highly paraphrased) of the facts and events that led to the ultimate decision by the Supreme Court bears mentioning:

• The Creditor lent Rs. 20 lakhs to the Debtor on 16 January 2012
• Between 8 April 2012 and 30 December 2013, the Debtor repaid a total of just over Rs. 4 lakhs of the loan principal.
• The Debtor also issued a post-dated cheque for Rs. 20 lakhs to the Creditor on 17 March 2014 as security for the loan.
• The Creditor presented the cheque for encashment on 2 April 2014 but the cheque bounced due to lack of funds in the Debtor’s account.
• On 12 May 2014, the Creditor filed a criminal complaint against the Debtor under the provisions of s. 138 of the Negotiable Instruments Act (“NI Act”).

Role of S.138 of NI Act in Making Post-dated Cheques a Security

Section 138 of the NI Act is an oft-cited provision in cases before courts in India. The essence of the provision is that if a cheque is dishonored for (i) a lack of funds or (ii) if the drawer’s (the person writing the cheque) agreement with his bank is to only allow disbursement of amounts less than the amount of the cheque, then the drawer is ‘deemed to have committed an offence’ punishable with imprisonment up to 2 years or a fine.

The importance of s. 138 lies in the fact that if the cheque is dishonoured for the reasons stated, it becomes an offence (criminal). The intention of criminalizing the bouncing of cheques was to enhance the trust of the common man in this financial instrument and in the formal financial industry.

Had the dishonouring of cheques (under the conditions stated) not been criminalized, post-dated cheques would surely not have become an accepted security for debt. After all, unlike cash or bearer bonds which are assets in themselves, cheques are simply instruments or in other words conduits to the actual assets. The Sword of Damocles in the form of criminal action and possible imprisonment hanging over the drawer’s head presents a unique form of personal jeopardy.

Therefore, the Apex Court’s interpretation of any aspect of s.138 of the NI Act, which apart from the main provision also has 3 important provisos and 1 explanation, is crucial for creditors of all hues to understand.

Bone of Contention

In the instant case, the main issue was that the Debtor had repaid part of the original loan before the Creditor presented the post-dated cheque, held as security, to be encashed. The Debtor’s contention was that s. 138 clearly states that the provision only applies if the dishonoured cheque represents the debt in ‘whole or in part,’ i.e., if the cheque amount is equal to or less than the outstanding debt on the date of encashment.

Court’s Rulings

The Supreme Court considered various aspects of the use of post-dated cheques as security for debt and the applicability of s. 138 of the NI Act. Apart from the ingredients and provisos of the section itself there were other ingredients expounded by the Court for a Creditor to successfully apply s. 138. These ingredients are:

Sr. No.	Ingredient
1.	The date that the Creditor presents the post-dated cheque for encashment must be on or after the date of maturity of the underlying debt.
2.	On the date of encashment, the cheque amount must be less than or equal to the outstanding debt on that same date.
	In case part of the debt has been repaid prior to the date of encashment of the security cheque such that the amount shown on the cheque is more than the outstanding debt, the Creditor must have the cheque endorsed under s. 56 of the NI Act to reflect the lower outstanding amount.
3.	The cheque must be presented for encashment to the bank within 6 months of its drawn date.   Note: As per RBI notification dtd. November 4, 2011, cheques are valid for a period of 3 months after the date of the instrument, hence the shortened period will have to be observed despite provisions of s.138 of NI Act.
4.	The Creditor would need to serve a notice on the Debtor within 30 days of learning that the security cheque has been dishonoured. The notice cannot be an omnibus notice or general demand for repayment but must specifically mention the ‘cheque amount.’   Note: While not expressly clarified in the instant judgement, it seems clear that the ‘cheque amount’ in the notice must be the endorsed amount in case of part repayment of debt.
5.	After serving the notice as in point (4), if the Debtor fails to pay the quoted amount within 15 days of receiving the notice, then the Creditor can file a civil suit or a criminal complaint invoking s. 138 of the NI Act.

Side Note on Terminology of Dates

While the instant judgement is quite clear in its principles upon reading, there does seem to be some confusion with regards to the terminology used for important dates related to the cheque itself and to the underlying debt.

In banking parlance the only formal date related to a cheque is the ‘drawn date’ which is the date actually written (usually on the top righthand corner) on the cheque. This is the date from which point on the cheque becomes valid or cashable. However, from reading the instant judgement the term seems to be sometimes also used to refer to the date the cheque is actually written/issued to payee.

However, for post-dated cheques terms such as issue date or written date are also used colloquially to refer to the date on which the post-dated cheque was actually written by the drawer or physically handed over to the payee.

In the instant judgement, another date mentioned is ‘date of maturity.’ However, this ‘maturity date’ seems to have been used interchangeably as referring to either the date when the underlying debt matures (as in paragraph 15 [i]) or as the date mentioned on the cheque i.e. the drawn date (as in paragraph 17).

The confusion around terminology of dates doesn’t affect the final ingredients that the Creditor must satisfy to rely upon s. 138 of the NI Act. From the earlier table of ingredients, for the Creditor under s. 138 the most important date is clearly the date of encashment of the cheque.

Implications

From an action point-of-view, the most important part of this judgement is the reference to the option of endorsement available under s. 56 of the NI Act (called ‘indorsement’ in the Act). If part repayment of the underlying debt/liability does happen before date of attempted encashment of the security cheque, and consequently the cheque amount is greater than the outstanding debt, then without endorsement the cheque becomes worthless as a security.  

Therefore, in cases where the Debtor after issuing a post-dated cheque as a security to the Creditor partly repays the debt, which is presumably very common, the Creditor would need to undertake one of the following steps to maintain his secure position:

1. Seek a new cheque from the Debtor to the tune of the new outstanding debt amount.
2. Get the original post-dated cheque endorsed for the new outstanding debt amount.

Option 1 would clearly be very difficult to implement in practice. There would be no incentive at all for the Debtor to supply such a cheque and would likely drag his heels in doing so.

Option 2 is the more worthwhile option to pursue, however even in this case, the procedural implications could be messy. Moreover, the provisions of s. 138 are broad and do not just cover traditional loans and debt but also purposely ‘other liabilities’ as well which can include advances on purchase orders etc. Therefore, the gamut of what would be considered Creditors is quite wide and the impact of the requirement to endorse would be different for each category of Creditors. For example:

• For more informal lending, for example in the instant case wherein the two parties were simply two individuals, the Creditor may not even be aware that he would need to have the security cheque endorsed at the time of receiving a part repayment of the loan.
• The most startling impact could in fact be for companies whose main business activity is not lending related, but who as normal practice offer credit terms to their customers on the back of post-dated cheques. The accounting departments of these companies may simply not be equipped to handle the additional procedural burden.

Endorsement – The Problem and The Solution

Section 56 of the NI Act read with Section 15 provides for a long-term solution to the issue. Section 56 allows a cheque to be endorsed for a lower amount than stated if the sum due has been partly paid. Section 15 which defines ‘indorsement’ indicates who can endorse a cheque and the methods to do so. Importantly, s. 15 of the NI Act allows the ‘holder’ (essentially the payee) of the cheque to endorse it and indicates that endorsement need not be by writing on the actual cheque itself but can be done by affixing a ‘slip of paper’ to the cheque as well. These two provisions should ease the operational burden for creditors.

The question may be asked whether the Creditor can in fact unilaterally endorse a cheque to a lower amount. By common sense, the answer is yes. The Creditor i.e. the holder of the cheque is at the outset entitled to a certain amount on drawn date of the cheque. If the Creditor chooses to endorse the cheque indicating that he is willing to accept a lower amount than stated, the Debtor would hardly be expected to raise a ruckus. Luckily one doesn’t need to only rely on common sense to take such a call as the Kerala High Court in Joseph Sartho v. G Gopinathan & Anr³ stated that ‘the law contemplates making of an indorsement by the drawee on the back of the cheque regarding the part payment received’ (from context of the judgement ‘drawee’ seems to mean payee).

Best Practice

The only point of time that the Debtor is fully incentivized to aid the Creditor is when he is seeking the credit i.e. before any money is disbursed to him or any credit terms extended. That is precisely the time when the Creditor’s documentation and policies should be foolproof to protect him from the post-dated cheque becoming worthless as a security. Our suggestions are as follows:

1. The loan agreement/purchase agreement/credit terms agreed between the parties at the outset should necessarily require the Debtor to affirm that the Creditor has the right to unilaterally endorse the security cheque at the time of part repayment of the debt/liability. This is to prevent any last-minute anxiety for the Creditor in case there is an adverse judgement that opposes the ruling in cases such as Sartho v. Gopinathan (mentioned earlier).
2. On the date of part repayment of debt or liability, the Creditor should send a letter and/or email to the Debtor simply informing him that due to the part repayment the Creditor is endorsing the security cheque for the reduced outstanding principal.
3. A slip of paper can be affixed to security cheque as an endorsement of the reduced cheque amount. Point no. 2 is important from a practical standpoint as the slip of paper is likely to be affixed to the cheque only in the event that it is presented for encashment i.e. at a later date than the actual endorsement. Therefore, the letter/email in point no. 2 would help establish the proactive intention of the Creditor in case the Debtor or drawee bank disputes the validity of the endorsement at the time of cheque encashment.
4. In case the security cheque is presented for encashment but bounces for the reasons mentioned in s. 138, then in the notice that the Creditor sends to the Debtor, care must be taken to only demand the exact endorsed cheque amount and to also mention the timeline details that led to endorsement of the lower cheque amount including intimation to Debtor as in point 2.

Update – 21 November 2022

This article received excellent and insightful feedback as it seems to have touched on an issue which many legal and corporate practitioners have encountered personally.

One observation from Mr. A. Dhananjaya, a former colleague of the author, raised a new angle to the issue from the perspective of a large NBFC. He noted that with the advent of the Cheque Truncation System (CTS), banks and NBFCs no longer physically transfer cheques between each other rather they employ the CTS software to upload an image of the cheque which serves as equivalent to the physical instrument.

Therefore, in terms of Best Practice suggestion no. 3 mentioned earlier, it is quite possible that the the endorsement slip gets missed or simply falls off. There might be similar concerns with endorsing the back of the cheque where such an endorsement simply gets missed.

So the alternative solution that was suggested was that NBFCs and Banks could simply take blank cheques from the Debtor at the outset of the debt with an endorsement on the face of the cheque to the effect that ‘drawn amount would be limited to Rs. XYZ.’ With this method, if the Debtor did end up defaulting on a repayment, the Creditor could simply fill up the outstanding debt balance as on the date of the default and present the cheque for encashment.

From the author’s understanding and reading of statutes and caselaw this is a viable solution for the following reasons:

• As per section 139 of the NI Act, ‘it shall be presumed, unless the contrary is proved, that the holder of a cheque received the cheque of the nature referred to in section 138 for the discharge, in whole or in part, of any debt or other liability.‘ The Supreme Court in various decisions, notably Bir Singh v. Mukesh Kumar[3] has ruled that blank cheques carrying only the drawer’s signature are valid as security for debt. Further, in case of dispute over such blank cheques, the burden is on the drawer to prove that the cheque was not issued as security for a debt from the payee.
• As to the second part of the proposed solution i.e. an endorsement on the face of the cheque – this is an option that is allowed under s. 15 of the NI Act. However, reading s. 139 of the Act along with the Bir Singh judgement mentioned earlier and the 4 Best Practices we had suggested, the simplest solution would be to simply mention in the loan agreement the procedure that the Creditor will follow if the security cheque needs to be encashed and to be conscientious about updating the Debtor with the outstanding loan balance whenever the Debtor makes a repayment. The need for endorsement is simply because the amount sought to be drawn at time of encashment is different from the amount stated on the cheque. Therefore, without such a difference there would be no need for an endorsement.

There are a few points of caution that a Creditor should keep in mind while exploring this solution:

1. The loan agreement and the communication with the Debtor should be very clear about the procedure that the Creditor intends to follow with respect to possible encashment of the security cheque. This is primarily to avoid falling foul of s. 87 of the NI Act which deals with ‘material alteration’ of the instrument. In essence, any material alteration made to a cheque that has either not been consented to by the other party or is not in the common intention of the parties to the cheque is void. Hence, although as per s. 139 of the NI Act, the presumption would be in the Creditor’s favour it would be wise to have a chain of evidence showing under what circumstances a blank security cheque was sought to be encashed for a particular amount.
2. Blank cheques are a particularly sensitive negotiable instrument for the drawer as the Bir Singh judgement proves. Therefore the Creditor must take pains to ensure:
   • That the Debtor has issued the blank cheques voluntarily.
   • That Creditor employs stricter precautions in handling such cheques. The onus would be higher on the Creditor’s side when holding a blank cheque to prevent any fraud or misuse.

Many thanks to Dhananjaya for his contribution to this update!

Final Words

Documentation work is often seen as mindless and mind-numbing, but in most cases documents are the only present indication of the past intentions of parties or events that are said to have occurred. The concern is for those whose activities do not primarily subsist on extensive documentation and the hope is that this article can provide a simple path forward without capsizing the boat.

References

1. 2022 SCC OnLine SC 1376 
2. 2008 SCC OnLine Ker 25
3. 2019 SCC OnLine SC 138