A Bill of Exchange, also known as a draft, is a written order made by one person directing another person to pay a specified amount of money to a third person. The person making the order is known as the Drawer, the person directed to make the payment is known as the Drawee, and the person in whose favour the payment is to be made is known as the Payee.
In simple accounting and banking terms, a Bill of Exchange is an instrument through which one person orders another person to pay money to a specified person. It is therefore essentially an order to pay money.
Bills of Exchange have traditionally been used as a means of payment and settlement of financial obligations. They have been particularly important in international trade.
Meaning of Bill of Exchange
A Bill of Exchange is a written order by the Drawer to the Drawee to pay money to the Payee.
The order relates to the payment of a specified amount of money. Payment may be directed to the person named in the instrument or according to the terms of the Bill of Exchange.
The basic structure of a Bill of Exchange involves one person issuing an order, another person being directed to make payment, and a person entitled to receive the payment.
Therefore, a Bill of Exchange essentially creates a payment arrangement among the parties to the instrument.
Nature of a Bill of Exchange
The most important feature of a Bill of Exchange is that it is an order to pay money.
One person makes the order and directs another person to make payment. The payment is made in favour of the person entitled to receive the amount.
A Bill of Exchange is therefore different from a simple payment of cash. It is a written financial instrument containing an instruction for payment.
The instrument may also be transferred from one person to another through endorsement. This transferable nature makes the Bill of Exchange a negotiable instrument.
Parties to a Bill of Exchange
A Bill of Exchange requires three parties at its inception. These parties are the Drawer, Drawee, and Payee.
Drawer
The Drawer is the person who draws or makes the Bill of Exchange.
The Drawer gives the written order directing another person to pay a specified amount of money.
Therefore, the Drawer is the person who initiates the Bill of Exchange and issues the payment instruction.
Drawee
The Drawee is the person upon whom the Bill of Exchange is drawn.
The Bill is addressed to the Drawee, and the Drawee is ordered to pay the amount specified in the instrument.
The Drawee is therefore the person who is directed by the Drawer to make payment.
Acceptor
The Drawee becomes an Acceptor when he indicates his willingness to pay the Bill of Exchange.
Acceptance represents the Drawee’s willingness to make payment according to the terms of the Bill.
Therefore:
Drawee + Acceptance of Bill = Acceptor
The distinction between a Drawee and an Acceptor is important for examination purposes. A person is initially the Drawee because the Bill is drawn upon him. When he accepts the Bill and indicates his willingness to pay, he becomes the Acceptor.
Payee
The Payee is the person in whose favour the Bill of Exchange is drawn or to whom the amount is payable.
The Payee is entitled to receive the amount specified in the Bill.
Therefore, the Payee is the beneficiary of the payment under the Bill of Exchange.
Three Basic Parties
The three basic parties to a Bill of Exchange may be summarised as follows:
Drawer → Gives the order to pay
Drawee → Person ordered to pay
Payee → Person entitled to receive payment
When the Drawee accepts the Bill, the Drawee becomes the Acceptor.
Understanding these parties is important because questions relating to Drawer, Drawee, Acceptor, and Payee are commonly based on the basic structure of a Bill of Exchange.
Parties Need Not Always Be Different Persons
The Drawer, Drawee, and Payee need not always be three completely different persons.
For example, the Drawer may draw a Bill on himself and make it payable to his own order.
Therefore, although a Bill of Exchange requires the functions of Drawer, Drawee, and Payee, these functions need not always be performed by three separate individuals.
The identity of the parties depends on the manner in which the Bill is drawn.
Cheque as a Bill of Exchange
A Cheque is a common type of Bill of Exchange.
A cheque is defined as a Bill of Exchange drawn on a banker and payable on demand.
Therefore, the important features of a cheque in relation to a Bill of Exchange are:
It is drawn on a banker.
It is payable on demand.
A cheque is therefore a specific form of Bill of Exchange having a banker as the Drawee and requiring payment on demand.
Use of Bills of Exchange in International Trade
Bills of Exchange are primarily associated with international trade.
In international transactions, a written payment order may be used to direct payment of a specified amount on a specified date.
A person may issue a written order directing a bank to pay a specific amount to the bearer or another entitled person according to the terms of the instrument.
Therefore, Bills of Exchange have traditionally provided a mechanism for payment in transactions where the parties may be located in different places or countries.
Historical Importance of Bills of Exchange
Before the development and widespread use of paper currency, Bills of Exchange were a common means of exchange.
They allowed financial obligations to be transferred and settled without the physical movement of money.
The use of Bills of Exchange therefore played an important role in commercial transactions and trade.
However, Bills of Exchange are not used as frequently today as they were historically.
Acceptance of a Bill of Exchange
Acceptance occurs when the Drawee indicates willingness to pay the Bill.
After acceptance, the Drawee becomes the Acceptor.
The Acceptor is therefore associated with the obligation to pay the amount of the Bill according to its terms.
For examination purposes, remember:
Before Acceptance → Drawee
After Acceptance → Acceptor
Acceptance changes the position of the Drawee by indicating willingness to make payment under the Bill.
Endorsement of a Bill of Exchange
A Bill of Exchange may be endorsed by the Payee in favour of a third party.
The third party may subsequently endorse the Bill in favour of another person. This process may continue through further endorsements.
Thus, a Bill of Exchange may pass from one person to another through endorsement.
For example:
Payee → Third Party → Fourth Party → Further Parties
The ability to transfer the Bill through endorsement is an important characteristic of a negotiable instrument.
Negotiability of a Bill of Exchange
A Bill of Exchange is generally a negotiable instrument.
Negotiability means that the instrument can be transferred from one person to another. A Payee may endorse the Bill in favour of another person, who may further endorse it to another person.
The person who lawfully receives the Bill may acquire rights relating to payment of the amount specified in the instrument.
Therefore, negotiability facilitates the transfer of the right to receive payment.
Holder in Due Course
A Holder in Due Course may claim the amount of the Bill against the Drawee and previous Endorsers.
The Holder in Due Course may have the right to claim the amount even where counterclaims could have prevented a previous Payee or Endorser from making the same claim.
This characteristic is connected with the negotiable nature of the Bill of Exchange.
Therefore, the rights of a Holder in Due Course may be stronger than the rights of a previous holder or transferor.
Previous Endorsers
When a Bill of Exchange is transferred through endorsement, several Endorsers may become associated with the instrument.
A Holder in Due Course may claim the amount of the Bill against the Drawee and previous Endorsers according to the negotiable nature of the instrument.
Thus, endorsement not only transfers the Bill but also creates a chain of parties through whom the instrument has passed.
Not Negotiable Bill
In certain cases, a Bill or cheque may be marked “Not Negotiable.”
A Bill marked Not Negotiable may still be transferred to a third party.
However, the third party cannot obtain a better right than the person who transferred the instrument.
Therefore, if the transferor has a limited or defective right, the transferee cannot acquire a superior right.
This is the important effect of the words “Not Negotiable.”
Negotiable and Not Negotiable Instruments
In a negotiable Bill of Exchange, a Holder in Due Course may acquire rights that allow the amount to be claimed against the Drawee and previous Endorsers.
In the case of an instrument marked Not Negotiable, the instrument may still be transferred. However, the transferee cannot obtain a better right than the transferor.
Therefore, the important distinction is related to the rights acquired by the transferee.
Exam Focus
A Bill of Exchange or Draft is a written order by the Drawer directing the Drawee to pay money to the Payee.
A Bill of Exchange requires three basic parties at its inception:
Drawer – Person who gives the order to pay
Drawee – Person who is ordered to pay
Payee – Person in whose favour the Bill is drawn or to whom payment is made
When the Drawee indicates willingness to pay the Bill, the Drawee becomes the Acceptor.
A Cheque is a Bill of Exchange drawn on a banker and payable on demand.
A Bill of Exchange may be transferred through endorsement. The Payee may endorse the Bill to a third party, who may further endorse it to another person.
A Holder in Due Course may claim the amount against the Drawee and previous Endorsers, even in certain situations where previous holders may have been affected by counterclaims.
A Bill marked “Not Negotiable” can still be transferred, but the transferee cannot obtain a better right than the transferor.
The most important examination sequence is:
Drawer → Draws and orders payment
Drawee → Receives the order to pay
Acceptor → Drawee after accepting the Bill
Payee → Receives the payment
Endorser → Transfers the Bill by endorsement
Holder in Due Course → May acquire the right to claim against the Drawee and previous Endorsers