Updated July 17, 2023
What are Bills of Exchange?
The term “bills of exchange” refers to written orders that are primarily used in international trade and these orders obligate one party to pay a specific amount of money to another party either on a predetermined date or on-demand.
In certain aspects bills of exchange are similar to promissory notes and checks – all of these can be drawn either by individuals or banks and can be transferred through endorsements.
Explanation
A bill of exchange is a written document that contains an unconditional order with the maker’s signature and it directs one party to pay a fixed amount of money tothe bearer of the document. Further, a bill of exchange is simply considered a draft until the drawee (the debtor) or someone on his/ her behalf accepts it. Typically, a bill of exchange is drawn by the drawer (the creditor) upon the drawee.
Features of Bills of Exchange
The following are the features of a bill of exchange:
- It has to be in writing.
- The maker must sign the bill of exchange and it must be stamped as required by the law.
- It represents an unconditional order to make payment.
- The amount of payment, the date of payment, and the party to paid must be certain.
- The sum of money captured in the bill of exchange is payable either on a predetermined date or on
How Does Bills of Exchange Work?
Bills of exchange are documents in writing that outline a drawee’s obligation to a drawer. Although it is not a contract per se, the parties involved (drawer, drawee, and payee) can use it to enforce the terms and conditions of a contract. It contains all the information pertaining to the obligation, such as specify whether the payment will be payable on-demand or on a specified date in the future and the usance period. However, a bill of exchange is enforceable only when the drawee accepts it.
Example of Bills of Exchange
Now, let us look at some of the examples of bills of exchange to explain how bills of exchange works.
- Example #1: Let us assume that David issued a bill of exchange for John after selling him goods worth$10,000 and it was payable after two months. In this case, David is the drawer of the bill and John is the drawee. Now, if David retained the bill for the two months and receives the full amount on the due date, then David is the payee. On the other hand, if David got the bill of exchange discounted from a bank, then the bank is the payee. This example shows how bill of exchange can be transferred from one party to another.
- Example #2: Let us assume that in the above example, David issued the bill of exchange on 15th September 2019, which was date of the purchase. However, John didn’t accept the bill until 22nd September 2019. In this case, the issued document was a mere draft for 7 days from 15th September 2019 to 22nd September 2019. Only after John’s acceptance, the issued document became a bill of exchange. The example illustrates the importance of the drawer’s acceptance.
- Example #3: Again let us take the above example and assume that although John accepted the bill of exchange on 22nd September 2019, he couldn’t make the payment on 21st November 2019, which was the due date. In this case, the bill of exchange will be considered “dishonored”. This example illustrates the importance of the due date.
Types of Bills of Exchange
The bills of exchange can be broadly classified into two major categories:
- Bills of exchange payable on sight: In this type of bill, the obligation is payable on demand by the drawee to the drawer/ payee when the bill of exchange is presented for payment.
- Usance bills of exchange: In this type of bill, the obligation becomes payable only after expiry of the usance period, which is a predetermined period of time.
Parties to Bills of Exchange
In any bill of exchange, a maximum of three parties can participate. They are:
- Drawer:It is the party who sells the goods, issues the bill of exchange, and is yet to receive the money from the debtor.
- Drawee:It is the party who purchases the goods on credit and to whom the bill of exchange is issued. Basically, drawee is the debtor and the drawer is the creditor.
- Payee:It is the party that finally receives the payment on the due date. If there is no transfer of the bill of exchange, then the drawer and the payee is the same.
Advantages
Some of the major advantages are as follows:
- Given that it is a legal document, it makes the process of recovery much easier in case of default by the drawee.
- The bill bearer can get the bills of exchange discounted from a bank at any time before the due date.
- The bills of exchange can be easily transferred from one party to another through endorsement.
Disadvantages
Some of the major disadvantages are as follows:
- As bills of exchange are primarily used for short-term purposes, banks usually don’t consider it to be a good investment option.
- Due to bill discounting, the bill bearer has to tolerate an additional cost.
Importance of Bills of Exchange
An international trade bill of exchange helps in mitigating some of the risks involved with exports and facilitates long-term trading arrangements between firms from different countries. Issuance of bills of exchange means an assurance of a fixed price which helps in overcoming the risk of exchange rate fluctuations.
Further, the exporters can also safeguard themselves by drawing up the bill of exchange with their own bank and then presenting it to the importer’s bank. In such a case, even if the drawee fails to honour the bill, the importer’s bank will pay the bill to the payee and then chase the drawee.
Conclusion
So, it can be seen that bills of exchange are an important part of international trade as it helps all the parties involved to have a smooth and transparent trading process. It safeguards the interest of both importers and exporters equally.
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