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:
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.
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.