cheque given for security of loan

Legal Analysis: Cheque Given for Security of Loan

Overview

The legal implications of a cheque issued as security for a loan are governed primarily by the Negotiable Instruments Act, 1881, particularly Section 138, which addresses the dishonour of cheques. The courts have established that a cheque issued as security is not merely a worthless piece of paper but represents a legally enforceable obligation under certain conditions.

Key Legal Principles

1. Nature of Cheque as Security

A cheque issued as security for a loan is considered a pledge of payment, ensuring the fulfilment of the borrower''s obligation to repay the loan. It cannot be dismissed as worthless under all circumstances Psa Nitrogen Limited VS Satia Industries Limited - Punjab and Haryana Harshad Shambhulal Sheth VS Sangeeta Rajesh Varma - Dishonour Of Cheque.
If the borrower fails to repay the loan by the due date and there is no agreement to defer payment, the cheque matures for presentation, and the holder is entitled to present it for payment Jagat Ram Modka VS Ram Prakash Madaik - Himachal Pradesh SRIPATI SINGH (SINCE DECEASED) THROUGH HIS SON GAURAV SINGH VS STATE OF JHARKHAND - Supreme Court.

2. Legal Consequences of Dishonour

The dishonour of a cheque issued as security can attract penalties under Section 138 of the Negotiable Instruments Act. The courts have consistently held that the legal consequences of dishonour apply equally whether the cheque was issued for repayment or as security Sampath Kumar B. V. VS K. G. U. Lakshmi - Dishonour Of Cheque Kamruddin Ali VS Citi Financial - Dishonour Of Cheque.
The drawer of the cheque must demonstrate how the initial liability was discharged to avoid enforcement of the cheque Harshad Shambhulal Sheth VS Sangeeta Rajesh Varma - Dishonour Of Cheque Tarlochan Singh VS State of Punjab - Dishonour Of Cheque.

3. Burden of Proof

The burden lies on the drawer of the cheque to prove that the cheque was issued solely as security and that the underlying debt has been discharged. Failure to provide such evidence can lead to conviction under Section 138 G. Govindaraj VS P. Jaichand - Madras Sampelly Satyanarayana Rao VS Indian Renewable Energy Development Agency Limited - Supreme Court.
If the cheque was issued as security but the debt has matured and remains unpaid, the cheque can be presented for encashment, and the drawer cannot claim it was only a security cheque Thottathil Lakshmanan, S/o. Raman VS Kundathil Sobhana, W/o. Sathyan - Kerala M. Arul Kumar VS P. Shanmugam - Madras.

Exceptions and Counterarguments

If the borrower can prove that the loan was repaid before the cheque was presented, or if there was an altered understanding between the parties regarding the cheque''s status, the cheque may not be enforceable SRIPATI SINGH (SINCE DECEASED) THROUGH HIS SON GAURAV SINGH VS STATE OF JHARKHAND - Supreme Court Sampelly Satyanarayana Rao VS Indian Renewable Energy Development Agency Limited - Supreme Court.
The courts have also noted that mere assertions by the drawer that the cheque was issued as security, without supporting evidence, are insufficient to negate the presumption of liability M. Arul Kumar VS P. Shanmugam - Madras G. Govindaraj VS P. Jaichand - Madras.

Conclusion and Recommendations

A cheque issued as security for a loan is enforceable under the Negotiable Instruments Act if the loan is not repaid by the due date.
The drawer must provide clear evidence of repayment or any altered agreements to avoid liability.
It is advisable for parties involved in such transactions to maintain clear documentation of loan agreements and any communications regarding the status of repayment to mitigate legal risks.