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Bills of Exchange

Last updated date: 09th Apr 2024
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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 term 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.

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:

(Image Will be Updated Soon)

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.

The Correct Format of a Bills of Exchange would Look Like This:

To X. Y.

  • Nine months after date pay A. B. or order Rs. 5000

Sd/P. Q.

Date _________

Stamp —

FAQs on Bills of Exchange

1. What are the advantages of the Bills of Exchange?

The advantages of the Bills of Exchange are: Bills of Exchange is a legal document. In this exchange when the drawee fails to make payment in due time, the drawer can recover the amount legally. In the Discounting facility, if the drawer is in immediate need of funds, the bill can be converted into cash by discounting it from a bank by paying some bank charges. Endorsement of Bills of Exchange is performed with the adjustment and discharge of the debt from one person to another. The terms and conditions of this exchange are certain and can not be altered.

2. What are the limitations of Bills of Exchange?

Bills of Exchange implies an additional burden on the drawer if the bill is not accepted. The discount allowed on the Bills of Exchange is when encasing from the bank is an additional cost. The drawee is only liable to pay the bill in time as the period is fixed. The Bills of Exchange have a physical form so they can’t facilitate electronic payment. Bills of Exchange have to exist in physical form so it may be stolen, lost, or torn.

3. What are the important points in a Bills of Exchange?

The important points in a Bills of Exchange include: 

  • Date: It is important for the purpose of calculation of the due date of the bill.

  • Term: Term is the period after which the sum mentioned in the bill is to be paid. The term of the bill is three months and the term is agreed upon by the parties.

  • Amount: Amount is the sum payable is specified both in figures and words and this is done with a view to minimizing the possibility of alteration.

  • Stamp: It is attached to every bill of Exchange, except bills payable on demand. And the value of the stamp depends on the amount of the bill. The stamp is attached to the top left-hand corner of the bill.

  • Parties: There are basically three parties to a Bills of Exchange: Drawer, Drawee, and Payee.

4. What is a Bill of Exchange?

A Bills of Exchange is a type of agreement that is bound with one party to pay a fixed amount of cash on the determined date or on-demand to the other party. Bills of Exchange are mainly used in international trade. The Bills of Exchange have declined their use as other forms of payment have become more popular. There are basically three entities that are involved with a Bills of Exchange transaction: Drawer, Drawee, and Payee.

5. What is the difference between a Promissory Note and a Bills of Exchange?

There are two factors that differentiate a Bills of Exchange from a promissory note:

  • A Bills of Exchange is transferable. It can bind one party to make payments to a 3rd party who was not involved in the creation of the Bills of Exchange.

  • A Bills of Exchange is an order issued by the creditor to the debtor to pay a fixed sum of money within a stipulated time frame. A promissory note, on the other hand, is issued by the debtor who promises to pay a certain amount in the given time period.

6. What are some of the advantages of Bills of Exchange?

Bills of Exchange are frequently used in business because of the following advantages:

  • They provide a framework for the relationship. It enables a credit transaction between the creditor and the debtor on an agreed basis.

  • It is a convenient means of credit. A buyer can buy goods on credit by using a Bills of Exchange and then pay it after the credit period. Sellers can get immediate payment from banks by discounting the Bill or by endorsing it in favor of another party.

  • It is conclusive proof of a credit transaction. It implies that during the trade, the buyer received credit from the Seller. It makes the Seller liable for payment.

  • Bills of Exchange can be transferred easily. Through the process of endorsement and delivery, debt can easily be settled by transferring the bills.

  • There is a certainty with the terms and conditions in a Bills of Exchange. The creditor is certain of the time by which he would receive his payment and the debtor is equally aware of the date by which he needs to make the payment.

7. What are some of the disadvantages of Bills of Exchange?

Some of the disadvantages linked with the Bills of Exchange are:

  • Bills of Exchange are generally used for short-term service and not considered a good option for banking services.

  • If the Bills of Exchange are accepted by the bank, then it puts an extra burden on the person who draws it.

  • The discount that is allowed in this instrument also acts as an additional cost.

  • The drawee has to make the payment on time since the time of payment is fixed.

  • The governing laws that apply to all involved parties (drawer, payee, drawee) are often very complicated when there are chains involved. The chain of a contract is dependent on many factors like the nature of parties, location of parties, etc. and its validity has to apply in each local jurisdiction.