What is Bill of Exchange?
A Bills of Exchange can be defined as a type of written order or notice meant for international trades that binds one party to pay a definite amount of money to another party on demand or at a pre-decided date. A Bills of Exchange is mostly used in international trade to help importers and exporters fulfill transactions. A Bills of Exchange is different from a contract but can be used by the involved parties to specify the terms and conditions of a transaction, such as the credit terms and the rate of accrued interest. There are basically three parties that may be involved with a Bills of Exchange transaction namely: Drawee, Drawer, and Payee.
Drawee: Drawee is the party that pays the amount stated on the Bills of Exchange to the payee.
Drawer: The drawer is the party that makes the drawee pay a third party or the drawer can be paid by the drawee.
Payee: The payee is the party that is paid the amount specified on the Bills of Exchange by the drawee.
Bills of Exchange can be defined as a financial instrument that is short-term and negotiable and consists of an order in writing. This written order is essentially used in international trade where one party is bound to pay a fixed amount of money (either on-demand or at a predetermined rate) to another party.
The different parts of the Bills of Exchange are:
The Seller of goods who writes the Bills of Exchange. The instrument is addressed to the buyer.
The buyer must pay the Seller on demand (a sight draft) or at a fixed, determinable time in the future (also called time draft).
A specific sum of money that the buyer owes to the Seller.
Bills of Exchange are also known as the draft. The speciman Bills of Exchange can also be applied to other instruments of foreign exchange. Some of those include traveler’s checks, express orders, cable and mail transfers, postal money orders and letters of credit.
History of Bills of Exchange
As per history, Bills of Exchange were a means of settling accounts in international trading. It was used as early as the 8th century by Arab merchants. By the 13th century, it had attained wide use in its present form amongst the Lombard in northern Italy.
Since the merchants or buyers had their assets dispersed in various banks in many trading cities, it was not possible to get immediate payment by the shipper or seller by a banker. The shipper would present a Bills of Exchange to the banker who would purchase it at a discounted price (since payment was due in the future). The buying merchant's account would be debited at the due date as per the date mentioned in the Bills of Exchange. Bills could also be drawn on the banks directly. Once the Seller received his payment, the Bills of Exchange continued to function as a credit instrument until it reached its maturity.
Features of Bill of Exchange
The key features of a bill of exchange include:
1. It is a written, unconditional order to pay a specified sum.
2. It involves three parties: drawer, drawee, and payee.
3. It specifies the amount and maturity date.
4. It can be transferred by endorsement.
5. It requires acceptance by the drawee for validity.
6. It can be dishonored if payment is not made.
Essential Elements of Bills of Exchange
A Bills of Exchange introduction would require you to get familiarized with a few terms and also the elements of Bills of Exchange. Let us first learn some terms:
Drawer: This is the maker of the Bills of Exchange.
Drawee: The person who has been directed to pay the sum of money mentioned in the Bill is referred to as the drawee.
Payee: The person who will be receiving the money is termed as the payee.
Holder: When the payee is in Bill's custody, he is referred to as the holder. The holder must provide the Bill to the drawee for the latter's acceptance.
Acceptor: When the drawee signs the Bills of Exchange as a mark of his acceptance, then he becomes the acceptor of the Bill.
Drawee in Case of Need: At times, another person's name is mentioned in the Bills of Exchange, who would accept the Bill in case the original drawee does not accept the Bill. This 3rd person is called drawee in case of need.
Endorser: If the bill holder endorses it to another person, then he will be called an endorser.
Endorsee: This is the person to whom the Bills of Exchange has been endorsed.
With this knowledge, let us look at the essential elements of Bills of Exchange:
The Bills of Exchange have to be in writing.
The Bill must be signed by the drawer.
The instrument needs to have an order to pay; the order should be:
Express
Unconditional
All three entities payee, drawer and drawee must be definite individuals.
The amount of money due should be certain.
The payment must be made in the legal tender currency of that specific country.
The instrument must be properly stamped.
The money should be payable to a certain and definite person or as per his order.
The drawer and payee, in most cases, are the same person as the drawer usually draws the Bill in his or her favor.
The drawer and the drawee can not be the same person.
The process of how a Bills of Exchange flows between different parties is depicted in the flowchart below:
Types of Bills of Exchange
There are mainly two types of Bills of Exchange:
Bills of Exchange Payable at Sight – They are payable on demand. When the Bill is given to the drawee, he or she must pay the amount.
Bills of Exchange After a Certain Period– This is also called term draft and becomes payable after a certain time period.
Documentary Bills of Exchange: It is always accompanied by supporting documents to facilitate the trade or transaction between two parties is called a documentary bill. There are two types of Documentary Bills of Exchange: Documents against acceptance Bills and Documents against payment.
Demand Bill: A Bills of Exchange that is payable on demand or when presented at the site is called a demand bill and it does not have a due date or time mentioned for the payment in it, so the transaction between the involved parties can be made when the bill is presented.
Usance Bill: Usance bill is also termed as time bill because it specifically mentions the time period and the due date for the payment on it and it is considered as a time-bound bill because of the mention of the specific time and period for payment.
Inland Bills: An inland bill is a type of bill that is drawn in India by an Indian resident and only payable in India and the same for any other country is known as an inland bill. This bill is quite the opposite of the Foreign bill.
Clean Bill: A type of bill that is without documents of proof is called a Clean Bill. In this bill no documents are present so the charges for this bill are higher with the higher interest rate in comparison to other documentaries.
Foreign Bills: Foreign bill is a type of Bills of Exchange where the charges to be paid are outside India. Whichever bill is not Inland is the Foreign bill. Foreign bills are further divided into Export bills and Import Bills.
Accommodation Bill: If a bill is accepted or drawn without any conditions involved are termed as an accommodation bill.
Trade Bill: A type of Bill that is drawn for the purpose of a trade order transaction is termed a trade bill. These bills are common in the case of international trading.
Supply Bills: Supply bill is a type of bill that is drawn to supply certain goods by any government department or by a supplier or by a contractor. To obtain cash for any pending payments from any financial institution for satisfying the financial requirements, supply bills are used.
Fictitious Bill: A fictitious bill is a type of bill in which the name drawn is fictitious that is either of drawer or drawee.
Hundis: Hundis are the type of bills that are used for agricultural financing and inland trade and are indigenous in nature.
Bills of Exchange in India
The Bills of Exchange in India are governed by the Indian negotiable instruments act, 1881. It appears in Section 5 of the negotiable instrument act. According to this, the order to pay is not “conditional” and the payable amount is “certain”. It also includes future interest and rate of exchange if there is a default in the payment.
The Reserve Bank of India and India’s Government are the only entities that can draw a bill payable on demand to the person who is the bearer of the Bill.
Importance of Bills of Exchange
The need and importance of Bills of Exchange are most evident when there is export involved. There are some risks related to exports of products which domestic businesses are not aware of. A Bills of Exchange can help in countering some of those risks related to the export of goods. Some of them are:
The constant fluctuations in the rate of exchange can adversely affect long term trading arrangements. In such a scenario, the fixed term of payment which is laid out in a Bills of Exchange can give assurance to the exporters of receiving a fixed price.
The exporter is also getting protection with a Bills of Exchange. The exporter can draw up a Bills of Exchange with their bank and submit it to the importer’s bank. This way, exporters gain an agreement in which they do not need to chase the importer for payment in the event the company fails to honor the agreement.
Adequate Time for Payment: Primarily Importers buying goods and services get a sufficient time limit to pay for the purchase by negotiating in Bills of Exchange.
Legal Action: Legal action serves as a basis for taking legal action in case the buyer fails to make the payment on the due date.
The Bills of Exchange helps to enhance the per capita income of the country and the government is benefited with the foreign trades.
Terms and Conditions: The Bills of Exchange can only be signed if the terms and conditions are read and accepted by the acceptor.
Easy Transfer: The Bills of Exchange are transferable that means the bill can be transferred to any third party including the endorsement and the liabilities related to it.
Mutual Accommodation: The Bills of Exchange are drawn to meet the financial needs of others. This bill is issued to accommodate the other party with the common decision.
Essentials Elements of a Bills of Exchange
The essential elements of a Bills of Exchange are:
A Bills of Exchange should always be a written document.
Bills of Exchange must be dated and stamped.
A Bills of Exchange must be signed by the maker or drawer.
The Bills of Exchange must clearly mention the name of the drawer.
The order for the Bills of Exchange must be an unconditional one.
A Bills of Exchange must have an order to pay money and not goods.
The sum payable for the Bills of Exchange must be specified.
The money for the Bills of Exchange must be payable to a definite person or to his order or to the bearer.
The amount for the Bills of Exchange should be paid within a stipulated time.
A Bills of Exchange must have adequate stamp duty at the prescribed rate.
Some Examples of Bills of Exchange
Let us get some clarity on what exactly a Bills of Exchange looks like by considering a few examples.
“Please let the bearer have 100 pounds and oblige” – This is not a Bills of Exchange since it is a request, not an order.
“We hereby authorize you to make a payment on our account to the order of Mr.X, $200” – This is again not an order hence not a Bills of Exchange.
Advantages of a Bill of Exchange
The advantages of a bill of exchange include:
1. It provides a secure method of payment.
2. It is a negotiable instrument that can be transferred to others.
3. It ensures legal recourse if payments are not made.
4. It facilitates credit, reducing the need for immediate cash payments.
5. It enhances trust in trade transactions, especially in international trade.
What is Promissory Note?
A promissory note is a written, legally binding document in which one party (the maker or issuer) promises to pay a specific sum of money to another party (the payee) at a predetermined date or on demand. A promissory note is often used in personal or business loans and can be a standalone document or part of a larger agreement. It is legally enforceable and may be used as evidence in case of disputes. It serves as a formal acknowledgment of a debt and outlines the terms of repayment, including:
Principal amount: The total amount of money to be paid.
Interest rate (if applicable): The rate charged for borrowing the money.
Payment terms: Whether it is payable in installments or as a lump sum.
Due date: The date by which the payment must be made.
Parties involved: Names of the borrower (maker) and lender (payee).
Importance of Promissory Note in Bill of Exchange
1. A promissory note provides a clear record of the loan agreement between the lender and borrower.
2. It ensures that both parties are aware of the exact terms, including the amount, interest rate, and repayment schedule.
3. It serves as a legally binding document that can be enforced in a court of law.
4. It holds the borrower accountable for repayment, reducing the risk of disputes.
5. It can be customized to meet the specific needs of the parties involved.
6. It acts as proof of debt, which can be used in financial or legal matters.
7. It provides security to lenders, especially if collateral is included.
8. It helps in maintaining trust and transparency between the lender and borrower.
9. It facilitates easier borrowing and lending by formalizing informal financial transactions.
10. It protects the interests of both parties, reducing misunderstandings or potential conflicts.
Parties to a Promissory Note
The parties to a promissory note are:
1. Maker: The person or entity who creates and signs the promissory note, promising to pay the specified amount to the payee.
2. Payee: The person or entity to whom the payment is to be made, as stated in the promissory note.
In some cases, there may also be additional parties involved:
3. Holder in due course: A third party who acquires the promissory note in good faith, for value, and without knowledge of any defects or disputes.
4. Endorser: If the payee transfers the promissory note to another party, the payee becomes an endorser by signing the note.
5. Endorsee: The person or entity to whom the note is transferred by the endorser.
FAQs on Bills of Exchange: Features and Importance
1. What are bills of exchange?
A bill of exchange is a written, unconditional order from one party (the drawer) directing another party (the drawee) to pay a specific sum to a third party (the payee) at a fixed or determinable future date. This financial instrument is commonly used in international trade and commerce to guarantee payment between buyers and sellers. By setting clear terms for payment, bills of exchange help facilitate transactions and reduce risk by providing a legally binding document. Overall, bills of exchange provide a reliable mechanism to ensure payment, increasing trust between trading partners and improving cash flow in business.
2. What is an example of a bill of exchange?
A typical example of a bill of exchange occurs during international goods trade. For instance, a manufacturer in France sells $10,000 worth of machinery to a retailer in India. The French seller draws a bill of exchange instructing the Indian buyer to pay the amount in 90 days. The Indian buyer accepts the bill by signing it, promising to pay the stated sum on the due date. In this example, the bill of exchange acts as a written commitment, outlining the payment details and deadlines. Such instruments help manage trade credit, ensuring sellers are paid and buyers have time to arrange funds.
3. Can you buy a house with a bill of exchange?
While bills of exchange are primarily used in commercial and international trade transactions, they are rarely used for purchasing a house. Real estate purchases generally require more secure and regulated methods of payment, such as bank transfers, certified checks, or escrow arrangements, to ensure ownership and legal compliance. Additionally, real estate laws and property registries often do not accept bills of exchange as valid payment proof. In summary, although theoretically possible, bills of exchange are unsuitable and rarely used for house purchases due to reliability and legal requirements.
4. What did bills of exchange do?
Bills of exchange played a crucial role in the development of modern trade and finance. They allowed merchants to safely transfer large sums of money across distant regions without carrying cash, reducing the risk of theft or loss. Their main functions included:
- Facilitating secure payments in domestic and international trade
- Providing a formal credit instrument backed by law
- Helping standardize commercial transactions and record-keeping
Thus, bills of exchange enabled more complex and trustworthy business exchanges, helping economies grow by making trade more accessible and secure.
5. What are the main parties involved in a bill of exchange?
Every bill of exchange involves three primary parties, each with distinct roles. These parties include:
- Drawer: The party who creates and signs the bill, typically the seller or creditor.
- Drawee: The party to whom the order to pay is addressed, usually the buyer or debtor.
- Payee: The party who receives the payment, which can sometimes be the same as the drawer.
Clear identification of these parties is required for the bill of exchange to serve as a valid and legally enforceable payment instrument.
6. How does a bill of exchange differ from a cheque?
A bill of exchange and a cheque are both negotiable instruments, but key differences exist between them. A cheque is always payable on demand, and drawn on a bank, whereas a bill of exchange can have a future due date and may be drawn on individuals or companies as well as banks. Additionally, a cheque must be paid when presented; a bill of exchange allows for acceptance and payment at a later date. In summary, cheques are used for immediate payments, while bills of exchange can facilitate delayed or future transactions between various parties.
7. What are the advantages of using a bill of exchange?
Bills of exchange offer several advantages for businesses and individuals managing trade payments. They provide:
- Legal security: Bills are legally enforceable contracts, ensuring payment.
- Credit extension: Sellers can offer buyers deferred payment terms without direct cash outlays.
- Transferability: Bills can be endorsed and transferred to others, offering flexibility as negotiable instruments.
These benefits make bills of exchange a flexible, reliable, and widely accepted payment method, particularly in international trade.
8. What happens if a bill of exchange is dishonoured?
If a bill of exchange is dishonoured, it means that the drawee refuses or fails to pay the amount on the due date. This situation can have legal and financial consequences. The holder of the bill can seek immediate legal action or compensation from the drawer and any endorsers. A notary public may also formally record the dishonour by noting or protesting the bill. Ultimately, dishonour of a bill undermines trust and may damage business relationships, so parties often try to resolve payment issues promptly to avoid further complications.
9. Are bills of exchange negotiable instruments?
Yes, bills of exchange are negotiable instruments. This means they can be transferred from one party to another by endorsement and delivery, making them valuable in trade and finance. The payee or current holder can endorse the bill to someone else, who then gains the right to collect the payment at maturity. This transferability allows bills of exchange to be used as a substitute for money, providing flexibility in managing business transactions and settling debts.
10. What is the difference between a bill of exchange and a promissory note?
While both bills of exchange and promissory notes are negotiable instruments, their structures are different. A bill of exchange is an order from one party to another to pay a third party, while a promissory note is a direct promise by one party to pay another. In a bill of exchange, three parties are involved—the drawer, drawee, and payee; in a promissory note, only the maker and payee are present. This distinction affects how each instrument is drafted, used, and enforced in commercial transactions.
11. What are the essential features of a valid bill of exchange?
A valid bill of exchange must meet specific legal criteria to be enforceable. The essential features include:
- Written form: The bill must be in writing.
- Unconditional order: The payment order must not depend on any condition.
- Definite sum: The amount to be paid should be clearly stated.
- Signature: The drawer must sign the bill.
- Payee identification: The person to whom payment is to be made should be specified.
- Date and maturity: The bill should mention the date of issue and due date for payment.
Meeting these requirements ensures the bill is recognized in legal and financial systems and offers protection to all parties involved.
12. How is a bill of exchange used in international trade?
In international trade, a bill of exchange is commonly issued by exporters to ensure payment from importers. The exporter draws the bill requiring the importer to pay a certain amount at a future date, often through their bank. Banks may guarantee payment by accepting or confirming the bill, reducing risk for both parties. This process offers exporters security, while importers gain time to receive, inspect, and sell goods before paying. Such use of bills of exchange helps facilitate global trade by creating trust and clear payment terms across borders.
