The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. The term comes from the English and is defined as an unconditional order in writing that is addressed by one person to another and signed by the person giving it. Bills of exchange, also referred to as commercial bills, were initially developed in inland trade by merchants who wished to resell goods before making a payment on them. Later they came to be used as a type of IOU in international trade.
In a bill of exchange transaction, a person, or the drawer, agrees to pay to another, also known as the drawee, a sum of money at a given date, usually three months ahead. In principle, the bill of exchange operates much a like a postdated check in that it can be endorsed for payment to the bearer or any other person named other than the drawee.
If the person accepts the bill of exchange by signing his name, or his name with the word "accepted," across the face of the paper, he is called an acceptor. The person to whom a bill is transferred by the acceptor's endorsement is called the endorsee. Any person in possession of a bill, whether as payee, endorsee, or bearer, is termed a holder. The basic rule applying to bills of exchange is that any signature appearing on a bill obligates the signer to pay the specified amount drawn on the bill.
The bill of exchange then must be accepted or "endorsed" by an accepting house, an institution that deals exclusively with bills of exchange, such as a bank, or a trader. Once the bill is accepted, the drawee does not have to wait for the bill to mature before receiving his funds. If he so chooses, the drawee can also sell the bill on the money market for a small discount.
A bill of exchange can also be passed beyond the drawer, drawee, and creditor. For the purposes of payment or borrowing, the creditor may transfer the bill of exchange to a fourth party, who in turn may pass it on and on through endorsement or signature of the transferor. Endorsement transfers the rights of the endorser to the new holder and also creates a liability of the endorser for payment of the amount of the draft if the drawee does not meet payment when the draft is due. A failure to pay a draft must be more or less formally recognized, and the draft holder may claim payment from any endorser whose signature appears on the instrument.
In English laws, bills of exchange were defined in the Bills of Exchange Act of 1882. The act later influenced American legislation, particularly the passage of the United States Negotiable Instruments Act, which was eventually adopted throughout the United States. However, English law of what constitutes a bill of exchange is somewhat different than bills of exchange laws in Europe and Asia. In 1988, the United Nations Commission on International Trade Law (UNCITRAL) began working to synchronize these laws through the "United Nations Convention on International Bills of Exchange and International Promissory notes." With the development of other means of credit, the use of bills of exchange has declined.
Hedley, William. Bills of Exchange and Bankers' Documentary Credits. London: LLP, 1997.
Jahn, Uwe. Bills of Exchange: A Guide to Legislation in European Countries, Asia and Oceania. Paris: ICC Publishing, 1999.
—Meg Greene Malvasi
A non-interest-bearing written order used primarily in international trade that binds one party to pay a fixed sum of money to another party at a predetermined future date.
Bills of exchange are similar to checks and promissory notes. They can be drawn by individuals or banks and are generally transferable by endorsements. The difference between a promissory note and a bill of exchange is that this product is transferable and can bind one party to pay a third party that was not involved in its creation. If these bills are issued by a bank, they can be referred to as bank drafts. If they are issued by individuals, they can be referred to as trade drafts.
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