Understanding Bounced Cheques: Essential Information You Must Be Aware Of

Cheques remain a widely used negotiable instrument in business transactions. As an SME, a bounced cheque can disrupt your business’s financial operations. Understanding the consequences of a bounced cheque becomes even more important when you are seeking msme loan. In this article we will understand about bounced cheques, the reason for their bouncing, their impact on your business, and alternatives to cheques.

What is a Bounced Cheque?

A bounced cheque or a dishonored cheque, occurs when a bank refuses to process a cheque payment.

Common Reasons for Cheque Bouncing

1. Insufficient Funds: The most frequent reason for cheque bounce is insufficient funds in the account. When the account balance is lower than the cheque amount, the bank returns the cheque unpaid. This affects your business’s credibility and may also impact your business loan eligibility.
2. Account Closure: A closed account dishonors a cheque drawn on it. This situation occurs if the account holder closes the account without informing all parties who have outstanding cheques. For businesses with active loans like term loans or lines of credit, it’s important to update banking information immediately to avoid such issues.
3. Stop Payment Orders: When a bank receives a cheque with a stop payment order, it will return it, resulting in a bounced cheque. Though this is a valid reason, it’s important to use this option judiciously to maintain good financial standing.
4. Technical Issues: Cheques also bounce due to technical reasons such as signature mismatch, date issues, or differences in the written and numerical amounts. These errors lead to cheque return charges and potential legal complications.

Legal Implications of Bounced Cheques

The Negotiable Instruments Act, 1881

Section 138 of the Negotiable Instruments Act, 1881 is the primary law dealing with check dishonor in India. Key points of Section 138 include:

• It applies to cheques issued for the payment of debt or liability.
• The payee (receiver) must present the cheque within its validity period (usually 3 months).
• If the cheque bounces, the payee must send a written notice to the drawer (payer) within 30 days of receiving the “cheque return” memo from the bank.
• The drawer then has 15 days to make the payment.
• If the drawer does not make payment within this period, the payee can file a criminal complaint within one month.

Penalties

• The court can impose a fine of up to twice the cheque amount.
• The banks levy check return charges that range from ₹50 to ₹750 per bounced cheque.
• The offense is punishable with imprisonment for up to two years.

Impact on SMEs

Financial consequences: Banks charge ₹50 to ₹750 per bounced cheque. These fees can accumulate quickly for businesses that deal with cheque transactions. These accumulated charges strain your business’s cash flow.

Damage to business relationships and reputation: When a bank returns a cheque due to insufficient funds or a stop payment order, it damages business relationships with suppliers, vendors, and customers. Suppliers might demand upfront payments or refuse to extend credit terms. This affects your purchasing power and operational flexibility.

Credit score implications: Repeated instances of cheque dishonor can damage your credit score. Banks and financial institutions report bounced cheques to credit bureaus, which can lower the business’s creditworthiness. A poor credit score can have negative consequences like loan eligibility for various financial products such as term loans, working capital loan, or equipment financing. FlexiLoans offers term loan upto ₹1 crore with various flexibility in terms of payment schedule, interest rates, and collateral requirements

Operational disruptions: When payments to suppliers or service providers fail due to cheque dishonor, it results in delayed or canceled deliveries. This leads to interruptions in the supply chain, missed deadlines, unfulfilled customer orders, and potential loss of business.

Increased scrutiny and reduced financial flexibility: With repeated instances of cheque dishonor, banks place – stricter monitoring of accounts, reduced overdraft facilities, or even account closures in some cases. Such restrictions can limit your financial flexibility and ability to manage short-term cash flow fluctuations.

Preventive Measures for SMEs

Maintaining an adequate account balance: You should consistently monitor your account balance to ensure there’s always enough money to cover issued cheques. Consider setting up alerts for low account balances or maintaining a buffer amount.

Proper record-keeping and reconciliation: Regularly reconcile your bank statements with your financial records to track all incoming and outgoing payments. This practice helps identify any discrepancies and ensures you’re aware of your actual account balance. This leads to the prevention of cheque bounce incidents.

Using post-dated cheques responsibly: When issuing post-dated cheques, ensure you’ll have sufficient funds in your account on the due date. Mark these dates in your calendar and set reminders to transfer funds if necessary. Be cautious when accepting post-dated cheques from others, as they may lead to cheque return charges if dishonored.

Implementing internal controls:

• Limit cheque signing authority to trusted individuals.
• Implement a dual-signature system for high-value cheques.
• Regularly review and update the list of authorised signatories.
• Ensure your team understands cheque bounce rules and the potential legal action for bounced cheques.
• If you anticipate cash flow issues, communicate with your creditors to arrange alternative payment terms or extensions.

What to Do When Your Cheque Bounces

Contact your bank: As soon as you’re notified of a cheque dishonor, reach out to your bank to understand the reasons for cheque bounce.

Arrange funds: If insufficient funds were the cause, transfer money into your account immediately to cover the cheque amount and any additional charges.

Contact the payee: Reach out to the cheque recipient to explain the situation and discuss solutions. Open communication can prevent escalation to legal action for bounced cheques.

Propose a payment plan: If you’re facing temporary financial difficulties, suggest a structured repayment plan. This could involve partial payments or a new payment date.

Reissue the cheque: Once you’ve ensured sufficient funds in your account, offer to reissue the cheque or provide an alternative payment method.

Respond to legal notices: If you receive a legal notice regarding the bounced cheque, respond promptly and professionally. Ignoring such notices can worsen your situation.

Explore settlement options: Even if legal proceedings have begun, it may be possible to negotiate a settlement with the payee to avoid a court case.

Attend court proceedings: If the matter goes to court, ensure you or your legal representative attends all hearings.

Role of Banks in Handling Bounced Cheques

Notification processes: When a bank dishonors a cheque, it promptly informs both the drawer (the person who wrote the cheque) and the payee (the person to whom the drawer wrote the cheque) about the cheque dishonor. This notification includes the reason for the bounce, such as insufficient funds or a stop payment request. Banks send these notifications via SMS, email, or postal mail, depending on the account holder’s preferences.

Charges and penalties imposed by banks: Banks impose various charges and penalties for bounced cheques to discourage this practice and cover their administrative costs. The charges are usually higher for frequent offenders. In addition to these penalties, repeated instances of bounced cheques affect your ability to secure financial services like a collateral free business loan.

Support services offered by banks:

• Banks can send notifications when they receive cheques for payment, helping account holders ensure sufficient funds are available.
• Banks may offer overdraft protection to cover cheques in case of temporary fund shortages.
• Banks often provide services to check the status of issued cheques, allowing drawers to take preventive action if necessary.

Alternatives to Cheques for SMEs

By adopting electronic payments, you can streamline your business operations and avoid legal action for bounced cheques. Some popular electronic payment options include:

• NEFT (National Electronic Funds Transfer): Ideal for transferring smaller amounts with no upper limit on transaction value.
• RTGS (Real-Time Gross Settlement): Perfect for high-value transactions, with a minimum transfer amount of ₹2 lakhs.
• IMPS (Immediate Payment Service): Offers instant 24/7 fund transfers, suitable for urgent transactions.
• UPI: Unified Payments Interface (UPI) allows instant fund transfers between bank accounts using a smartphone.
• Mobile Wallets: Enable quick payments and transfers through digital stored value accounts.

Advantages of digital transactions

• Digital transactions eliminate the possibility of cheque return charges and legal complications regarding dishonored cheques.
• Real-time transactions help businesses reduce the chances of insufficient funds scenarios.
• Digital payments are more secure than physical cheques, minimising the risk of fraud or theft.
• Electronic transactions have lower processing fees compared to cheque handling costs.
• Banks process digital payments more quickly than the 2-3 days they take for cheques.
• Electronic transactions provide digital trails, and simplifies accounting and auditing processes.

Conclusion

While cheques remain a common payment method, their mismanagement leads to consequences such as financial penalties, damaged business relationships, and legal complications. To mitigate these risks, you should implement robust financial practices, like maintaining adequate account balances and proper record-keeping. When a cheque does bounce, prompt action and open communication with all parties help resolve negative impacts. However, as we move towards a more digital economy, you should consider transitioning to electronic payment methods. Options like NEFT, RTGS, IMPS, UPI, and mobile wallets offer numerous advantages, like instant transactions and reduced risk of insufficient funds scenarios.

FAQs

Q1. What are the common reasons for cheque bouncing?

• The most frequent reason is the account doesn’t have enough balance to cover the cheque amount.
• When the signature on the cheque doesn’t match the bank’s records.
• In cases where the cheque’s source account is no longer active.
• When a bank receives a cheque for payment after its validity period (typically 3 months in India).

Q2. What are the legal implications of issuing a bounced cheque in India?

• If payment is not made, the payee can file a criminal complaint within 30 days of the notice period expiry.
• The drawer (issuer) of the bounced cheque can face imprisonment for up to two years or a fine of up to twice the cheque amount.

Q3. How does a bounced cheque impact your business operations and creditworthiness?

• Cash flow disruption: Funds that you are expecting become unavailable. This leads to difficulties paying suppliers, employees, or other obligations
• Credit score impact: In case of debt or business loan repayment, a bounced cheque can result in late payment. This impacts your credit score negatively.
• Increased scrutiny: Banks may monitor the account more closely which results in reduced credit limits or account restrictions.

Q4. What preventive measures can SMEs take to avoid cheque bouncing?

• Maintain sufficient account balance.
• Implement robust accounting practices.
• Set up overdraft protection or line of credit to meet unexpected shortfalls.
• Follow up on overdue payments promptly

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