Understanding Bills of Exchange: A Complete Guide

Introduction

A bill of exchange is one of the oldest and most versatile financial instruments in trade and commerce. Whether you’re a business owner, accountant, finance student or legal professional, knowing how bills of exchange work—and where to find their legal foundation—can help you manage credit transactions smoothly.

What Is a Bill of Exchange?

Under Indian law (Negotiable Instruments Act, 1881, Section 5), a bill of exchange is defined as:

“An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person…”

Key characteristics:

• Unconditional order: No “ifs” or “buts.”
• Written and signed: Must be in writing and bear the drawer’s signature.
• Specified parties: Names of drawer, drawee and payee must be clear.
• Certain sum: Exact amount must be stated.

The Three Core Parties

A bill of exchange starts life involving three principal parties:

1. Drawer
   The party who draws (creates and signs) the bill, ordering payment. Usually a seller or creditor.
2. Drawee
   The party on whom the bill is drawn and who is required to pay. Often a buyer or debtor. Upon acceptance (signing “accepted”), the drawee becomes liable.
3. Payee
   The party entitled to receive the payment. Often the same as the drawer initially, but may be a third party if the bill is endorsed.

Beyond the Basics: Negotiation and Endorsement

A bill of exchange is also a negotiable instrument—that is, its ownership can pass from one person to another:

• Endorsement
  The current holder (which may be the drawer or a subsequent payee) signs the back of the bill, transferring it to someone else.
• Endorser & Endorsee
  • The endorser is the party who signs and transfers.
  • The endorsee is the new holder entitled to payment.
• Holder in Due Course
  A person who acquires the bill for value, in good faith, without notice of defects. They have strong rights to enforce payment.

Types of Bills of Exchange

1. Demand Bill
   Payable on demand—“At sight,” “On presentation.”
2. Time Bill
   Payable after a fixed period—e.g., “Three months after date,” “Two months after sight.”

Legal Framework: Where to Look

• In India:
  • Negotiable Instruments Act, 1881
    • Section 5: Definition of bill of exchange
    • Sections 6–18 (Chapter II): Form, acceptance, negotiation, discharge
• In the UK:
  • Bills of Exchange Act 1882 (Section 3 gives an almost identical definition)

Acceptance, Dishonor and Discharge

• Acceptance
  When the drawee signs the bill, usually marked “Accepted,” it becomes prima facie the drawee’s promise to pay.
• Dishonor
  If the drawee refuses to pay or accept, the holder can protest the bill, preserving rights to claim damages.
• Discharge
  A bill may be discharged by payment, cancellation, waiver, or by lapse of time.

Practical Uses

• Trade Credit: Sellers grant buyers time to pay without resorting to short-term loans.
• Investment: Endorsers or holders in due course can trade bills at a discount.
• Legal Evidence: A bill accepted and dishonored creates clear proof of debt.

Conclusion

Bills of exchange remain a cornerstone of commercial finance, offering a secure, negotiable promise of payment underpinned by clear statutory rules. By understanding their definition (Sec. 5), the three core parties (drawer, drawee, payee), and how negotiation and acceptance work, you can leverage this instrument to streamline trade and manage credit effectively.