Post-dated cheques not a worthless paper

IBLJ | 23 December 2021

In debt transactions, it is fairly standard for lenders to accept post-dated cheques (PDC) from borrowers as security for the repayment of loans. But what if such PDCs bounce upon being presented for payment? In normal practice, when a cheque is dishonoured, section 138 of the Negotiable Instruments Act, 1881 (act) makes non-payment a criminal offence. However, the issue that has been long deliberated is whether PDCs that have been issued as security breach section 138.

Devyani Dhawan
SNG & Partners

The recent judgement of the Supreme Court in Sripati Singh v The State of Jharkhand and Ors. provided clarity, holding that a PDC issued as security is not a worthless piece of paper. In this case, four loan agreements were entered into, which recorded the advancement of six cheques as security towards payment of the loan. The loan was not otherwise repaid and the cheques were presented for payment but were dishonoured. As a result, complaints under section 138 were filed. The High Court of Jharkhand held that cheques issued as ‘security’ do not breach section 138. However, the Supreme Court quashed that judgment and held that although the word “security” was used in the loan agreements, it referred to the cheques being issued towards repayment of instalments. Once the loan was disbursed and instalments fell due on the date of each cheque, dishonour of such cheques would fall under section 138.

The Supreme Court further held that any contention that section 138 would not apply to cheques issued as security, would succeed only where the debt had not become recoverable and the cheque issued as security had not yet matured for payment. The court held that there cannot be a hard and fast rule that a cheque which is issued as security can never be presented by the payee. If such is the understanding, then a cheque would be reduced to an on-demand promissory note. Only civil litigation would be available to the creditor to recover the debt, which is not the intention of the statute.

Ayushi Parmani
SNG & Partners

The case clarifies the stand of the Supreme Court on PDCs, but the position of PDCs issued as security in loan transactions depends upon the factual matrix of each case. In Uma Maheswar Reddy v R. Srinivasa Rao, prior to the discharge of the debt the parties reached a settlement on payment. The PDCs issued when the transaction was made could not therefore have been issued in discharge of any legally enforceable debt. Section 138 would not apply. The Supreme Court in Indus Airways Pvt. Ltd. v Magnum Aviation Pvt. Ltd., held that where a cheque was issued as an advance for the purchase of goods and such order could not be completed because of contractual issues, the cheque could not attract criminal liability under section 138 as there existed no legally enforceable debt at the date when the cheque was drawn. However, this judgment has been distinguished in subsequent matters. In Sampelly Rao v Indian Renewable Energy Development Agency Limited the Supreme Court held that where the loan was disbursed and instalments fell due on the date of the cheques, dishonour of such cheques would trigger section 138.

Problems have also arisen where the PDCs were drawn by a guarantor, not the principal debtor. In ICDS Ltd. v Beena Shabeer and Ors., the Supreme Court held that the expressions any cheque and other liability in section 138 reflected the intentions of lawmakers. Where a cheque is issued as security in the discharge of any debt or other liability, there is no restriction to the application of section 138 just because it is issued by a guarantor.

In light of these decisions, the following factors must be present for section 138 to operate on the dishonour of PDCs issued as security:

  1. The debt should be in existence at the time the PDCs are issued;
  2. The debt has become recoverable;
  3. The instalment has fallen due on the date of the PDC;
  4. The transaction documents do not restrict the presentation of cheques, and
  5. There is no agreement between the parties in relation to settlement or termination, prior to the due date of repayment.

Lenders should bear these aspects in mind when they accept PDCs for the repayment of a debt, whether or not they are described as security under the relevant loan agreement.