Revisiting "Legally Enforceable Debt" & "Security" Under The Negotiable Instruments Act, 1881

This article highlights certain key aspects with respect to the principle of legally enforceable debt or other liability as per the Section 138 of the NIA in the light of judgments with different facts and circumstances thereby giving the current position of law with regard to the dishonour of cheque, security, legally enforceable debts, advance payment amongst others.

Factual Background

In December 2015, a Letter of Intent was issued by one company to the second respondent for providing power supply to the plant of the company situated at Aurangabad, Maharashtra.

In June 2016, the company communicated to the second respondent that it was issuing two cheques (Rs 1,33,92,000/- and Rs 2,67,84,000/- dated 28.08.2017) only for security and that the cheques were to be enchased only after getting the confirmation. Post-dated cheque amounting to Rs 2,67,84,000/- was accordingly issued with "to be deposited after confirmation only for security purpose" endorsed on its back.

The power supply commenced on 1.07.2016, and on 4.07.2016 the company addressed its bank to stop payment of the two cheques. Thereafter, on 24.07.2016, the parties entered into a Power Supply Agreement ("PSA"), and as per the same, the company was supposed to make payment to the second respondent by Letter of Credit ("LC"). During the period of August 2016 – September 2016, three LCs were issued to the second respondent.

The respondent issued invoices for power supply for the month of July 2016, August 2016, and September 2016.

However, on 20 October 2016, the company ended up terminating the PSA with the second respondent. Thereafter, the post-dated cheque which was issued by the company was deposited by the bank on the date of maturity, i.e., 28.08.2017, and the same was dishonoured owing to payment stopped by drawer. The second respondent thereafter preferred a criminal complaint against the company, the same complaint was challenged before the High Court whereby the petitions of the Appellants were dismissed.

Hence, the Appellants preferred their case before the Hon'ble Supreme Court.

Case Analysis and Rationale

It was submitted on behalf of the Appellants that complaint under Section 138 of the NIA would not be maintainable since the cheque was issued by way of security and not against any legally enforceable debt/ liability.

In order to support their claim, the Appellants placed reliance on the case of Indus Airways Private Limited vs Magnum Aviation Private Limited^[2], wherein a 2-judge bench of the Supreme Court allowed the appeal while observing that the explanation appended to Section 138 of the NIA treats dishonoured cheque as an offence, if the cheque has been issued in discharge of any debt or other liability. Moreover, the bench also observed that as per the explanation, the said debt/ liability should exist on the date the cheque is drawn, therefore the existence of debt/ liability on the date the cheque was drawn is sine qua non for bringing an offence under the ambit of Section 138 of the NIA. The Hon'ble Court further observed that "if a cheque is issued as an advance payment for purchase of the goods and for any reason purchase order is not carried to its logical conclusion either because of its cancellation or otherwise, and material or goods for which purchase order was placed is not supplied, the cheque cannot be held to have been drawn for an existing debt or liability". The Court finally stated that "the payment by cheque in the nature of advance payment indicates that at the time of drawal of cheque, there was no existing liability". Therefore, the issuance of a cheque towards advance payment at the time of the execution of the contract would not be considered as an existing liability to attract an offence under Section 138 upon the dishonour of the cheque.

The Court further considered the case of Sampelly Satyanarayana Rao vs Indian Renewable Energy Development Agency Limited^[3] which in turn had considered the case of Indus Airways. The Hon'ble Supreme Court distinguished the case of Sampelly from Indus Airways clarifying over the enforceable debt/ other liability. In Sampelly, the appellant was the Director of a company which was engaged in power generation, while the respondent was a government enterprise engaged in renewable energy. The respondent agreed to advance a loan for setting up a power project and the agreement envisaged that post-dated cheques towards payment of instalments of the loans would be given by way of security. The cheques were dishonoured, and complaints were instituted under Section 138 which led to quashing petitions filed before the High Court. Differentiation was made on the ground that in Indus Airways the cheque was not issued for discharge of liability but as advance for a purchase which was subsequently cancelled, however in Sampelly, the cheque was issued for repayment of loan which was due. Further, the Court went on to note that even though the deposit of cheques towards the repayment of instalments was described as a security in the loan agreement, the true test was whether the cheque was in discharge of an existing enforceable debt or liability or whether it was towards an advance payment without there being a subsisting debt or liability. Therefore, the appeal was dismissed, and an order was passed in favour of the respondent therein stating that the discharge of existing liability is covered under the NIA.

Another recent case of Sripati Singh v. State of Jharkhand^[4]was taken into consideration while clarifying over the subject dispute. In the case of Sripati Singh, there was a transaction between second respondent and the complainant pursuant to which the appellant had advanced sums of money and cheques were handed over to the complainant but were dishonoured on presentation. The order of the Magistrate taking cognizance and issuing summons on a complaint under Section 420 of the Indian Penal Code and Section 138 of the NIA to the second respondent was challenged before the High Court, and the High Court had allowed the petitions. The appellant preferred an appeal against the order of the High Court and the Hon'ble Supreme Court while placing reliance on both Indus Airways and Sampelly observed that where in the case of a loan transaction, the borrower agrees to repay the amount in a specified time frame and issues a cheque as a security to secure the repayment and the loan is not repaid, the cheque which is issued as security would mature for presentation once that specific date has reached/ time framed lapsed, and therefore the respondent could not be non-suited for proceedings under the NIA. The Court held that the argument that the cheque should be held as security even after the amount has become due as unsustainable.

While adjudicating the instant case of Sunil Todi, the Court also took note of Keshoram Industries v. CWT^[5] which was before the Hon'ble Supreme Court and went on to observe that the term debt also includes a sum of money promised to be paid on a future day by reason of a present obligation. A post-dated cheque issued after the debt has been incurred would be covered by the definition of 'debt'. However, if the sum payable depends on a contingent event, then it takes the colour of a debt only after the contingency has occurred. Considering the present case, the Hon'ble Court observed that:

"25…a debt was incurred after the second respondent began supply of power for which payment was not made because of the non-acceptance of the LCs'. The issue to be determined is whether Section 138 only covers a situation where there is an outstanding debt at the time of the drawing of the cheque or includes drawing of a cheque for a debt that is incurred before the cheque is encashed."

In the instant case the Hon'ble Supreme Court delved into the objective of the NIA while throwing light upon the intention of the parliament, the Court observed that the true purpose of Section 138 would not be fulfilled, if 'debt or other liability' is interpreted to include only a debt that exists as on the date of drawing of the cheque, and therefore with respect to the present case has observed the following:-

"26…In the present case, the cheque was issued in close proximity with the commencement of power supply. The issuance of the cheque in the context of a commercial transaction must be understood in the context of the business dealings. The issuance of the cheque was followed close on its heels by the supply of power. To hold that the cheque was not issued in the context of a liability which was being assumed by the company to pay for the dues towards power supplied would be to produce an outcome at odds with the business dealings. If the company were to fail to provide a satisfactory LC and yet consume power, the cheques were capable of being presented for the purpose of meeting the outstanding dues."

The Hon'ble Supreme Court further went on to observe that:-

"27…once payments for electricity supply became due in terms of the PSA, and the company failed to discharge its dues, the second respondent was entitled in law to present the cheque for payment. Merely labelling the cheque as a security would not obviate its character as an instrument designed to meet a legally enforceable debt or liability, once the supply of power had been provided for which there were monies due and payable. There is no inflexible rule which precludes the drawee of a cheque issued as security from presenting it for payment in terms of the contract. . It all depends on whether a legally enforceable debt or liability has arisen."

The Appellants urged that the cheques in the present case have been issued as security. The legal requirement with respect to section 138 is that a cheque must be drawn for the discharge, in whole or in part, of any debt or other liability.

However, the Court went on to observe that: -

"30…A cheque may be issued to facilitate a commercial transaction between the parties. Where, acting upon the underlying purpose, a commercial arrangement between the parties has fructified, as in the present case by the supply of electricity under a PSA, the presentation of the cheque upon the failure of the buyer to pay is a consequence which would be within the contemplation of the drawer. The cheque, in other words, would in such an instance mature for presentation and, in substance and in effect, is towards a legally enforceable debt or liability."

The submissions of the Appellants in the instant case as far as the issue of maintainability of Section 138 were concerned were negated while taking into consideration the specific facts of the case and the view taken by the Hon'ble Supreme Court in the aforementioned judgments, and it was therefore held that the complaint against the Appellant was legit.

The Hon'ble Supreme Court has rightly held that even though the cheque was issued as a security initially, the Appellants were liable for payment that was to be made towards the second respondent, which they failed to do. Therefore, upon maturation of the cheques, the second respondent was well within his right to deposit the same and pursue a remedy under Section 138 of the NIA upon the dishonour of these cheques. The Court has differentiated between the recent precedents in this area and has given a wide meaning to "or other liability" while taking into consideration the objective of the parliament while drafting the law of negotiable instruments. This case has rendered clarity upon the principle of legally enforceable debt/ other liability and security to a very wide extent thereby making this judgment a guiding precent for the time to come.

Authors:- Abhinav Shrivastava is Co-Founding Partner of GSL Chambers and an Advocate on Record of Supreme Court of India. Shivang Rawat is an Associate with GSL Chambers. Views are personal.