Dishonor of a Bill: Explained

When the drawee fails to make the payment on the date of maturity of the bill in case of dishonor, it is called dishonor of bill. Under the dishonor of the bill, the liability of the acceptor is restored. In this section, we will learn what is the treatment for the dishonor of bills and its relating effect which is shown bypassing journal entries.

Dishonor of Bill of Exchange

A bill is dishonored either by non-acceptance or by non-payment. That is, the person on whom a bill is drawn (the drawee) refuses to accept it or if he accepts the bill and agrees to pay but later fails to do so on the due date, then the bill of exchange is said to be dishonored. As per Section 42 of the Bills of Exchange Act, 1882, when a bill is duly presented for acceptance and is not accepted within the customary time, the person presenting it must treat it as dishonored by non-acceptance. If he does not, the holder shall lose his right of recourse against the drawer and indorses.

When the drawee of a bill of exchange is not able to make the payment for the bill on the date of maturity, it is called  Dishonor of bill. In such instances, the liability of the acceptor has been restored i.e. the holder of the bill can recover the amount from the drawer or any other previous endorsers. Therefore, the entries made on the receipt of the bill should be reversed.

A bill is said to be dishonored when the drawee is not able to make the payment on the date of maturity. A bill is said to be dishonored either by non-payment or by non-acceptance.

Dishonor by Non-Payment

A bill of exchange is said to be dishonored by non-payment when the drawee or other drawees who are not partners, makes default in paying when it was being duly required to pay the due. A promissory note, bill of exchange or cheque is said to be dishonored by non-payment when the maker of the note, acceptor of the bill or drawee of the cheque, commits a failure in payment upon being duly required to pay the same.  

The Negotiable Act further states that when a promissory note, bill of exchange or cheque is dishonored by non-payment, the holder or some party who remains liable must give notice that the instrument has been so dishonored. This is done to all other parties whom the holder seeks to make severely liable and to one of several parties whom he seeks to make jointly liable.

Dishonor by Non-Acceptance

According to The Negotiable Instrument Act 1881, A bill of exchange is said to be dishonored by non-acceptance when the drawee, not being partners, makes default in acceptance upon being duly required to accept the bill. It is said to be dishonored where presentment is excused and the bill is not accepted.

The bill may be treated as dishonored where the drawee is incompetent to contract or the acceptance is qualified. When a bill is duly presented for acceptance and is not accepted within the customary time, the person presenting it must treat it as dishonored by non-acceptance. If he does not, the holder shall lose his right of recourse against the drawer.

Features of Bill of Exchange

• The Bill of Exchange must be in writing

• The Bill of Exchange must include an unconditional promise to pay.

• The bill of exchange must be appropriately stamped and signed.

• The amount that needs to be paid i.e. the total amount payable must be certain.

• It must be signed by the maker and payable to a certain person.

Parties of Bill of Exchange

A bill of exchange comprises 3 parties: Drawer, Drawee, and Payee. 

Drawer: The drawer issues the bill of exchange. The bill is signed by Drawer, the maker of the bill of exchange. A drawer also referred to as a creditor who is authorized to receive payment from the debtor can draw a bill of exchange. 

Drawee: Drawee, also referred to as ‘Acceptor’, has to pay the money to the drawer. Drawee is the debtor, the person upon whom the bill of exchange is drawn. 

Payee: The payee is the person to whom payment of the bill has to be made, and he/she may be the drawer himself/herself or a third party.

Bill Discounted Dishonored

Bills discounted dishonored means the bill holder has been discounted from the bank by debiting bank charges in the form of a discount. However, at the time of maturity when the bank demanded money from drawee, drawee had no money and did not pay to the bank. Then it will be called a dishonored bill. At that time, the bank will go to the notary office to note this dishonor. Now, the bank will pay the note fees on behalf of the bill holder; later the bill holder will take the same amount from the drawee who accepted the same bill for payment.

When a bill of exchange discounted with a bank gets dishonored at the due date, in that case, the following effect is recorded as a journal entry:

In the books of Drawer:

In the books of Bank:

In the books of Drawee:

This entry overall implies that on dishonor, the drawee again becomes the debtor of the drawer and bank becomes the creditor of the drawer (due to non-payment by drawee on due date). 

Thus it can be concluded that a promissory note, bill of exchange or cheque is said to be dishonored when the maker of the note or the acceptor of the bill or the drawee of the cheque makes a default by not paying off the liability which lies upon him. Such a person has a liability or duty to discharge himself of the liability by making the payment as stipulated by the instrument. When he fails to do so the instrument is called to be dishonored.

Advantages of Bill of Exchange

The bill of exchange, an instrument of credit, is used often in businesses because of the following stated advantages:

Framework for relationships: A bill of exchange represents a device in writing containing an unconditional order. It provides a framework for enabling the credit transaction on an agreed basis between the seller/ creditor and buyer/debtor.

Certainty of terms and conditions: The creditor knows the time when he would receive the money so also the debtor is fully aware of the date by which he has to pay the money. This is because of the fact that terms and conditions of the relationships between drawer and drawee such as date of payment amount required to be paid,  interest to be paid if any, place of payment is clearly mentioned in the bill of exchange.

Convenient means of credit: The Buyer can buy the goods on credit and pay after the period of credit by means of the bill of exchange. However, by endorsing it in favor of a third party or by discounting the bill with the bank, the seller of goods can get the payment immediately even after the extension of credit.

Conclusive proof: The bill of exchange is referred to as legal evidence of a credit transaction. It implies that the buyer has obtained credit from the seller of the goods, therefore, he is liable to pay the seller during the period of the trade. In case of a refusal to make the payment, the creditor will have to obtain a certificate from the Notary in order to make it conclusive evidence of the happening according to the law..

Easy transferability: by transferring a bill of exchange through endorsement and delivery, A debt can be settled.