Bill of Exchange

A Bill of Exchange is a written, unconditional order by one party directing another to pay a specific sum of money to a designated person or bearer on demand or at a fixed future date. It is a vital financial instrument in both domestic and international trade, facilitating credit transactions and serving as a legally enforceable document of payment.
Governed primarily by the Negotiable Instruments Act, 1881 in India, the bill of exchange ensures smooth commercial dealings by providing a secure and transferable mode of payment between buyers, sellers, and financial institutions.

Definition

According to Section 5 of the Negotiable Instruments Act, 1881,

“A Bill of Exchange is 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 or to the bearer of the instrument.”

In simpler terms, it is an order from the drawer (creditor or seller) to the drawee (debtor or buyer) to pay a definite sum either immediately (on demand) or at a future date to a payee (the person receiving the payment).

Parties to a Bill of Exchange

A typical bill of exchange involves three principal parties:

1. Drawer: The person who makes and signs the bill, ordering payment. Generally, the seller or creditor.
2. Drawee: The person on whom the bill is drawn and who is directed to pay. Usually, the buyer or debtor.
3. Payee: The person in whose favour the payment is to be made. The payee may be the drawer himself or another person nominated by him.

After the drawee accepts the bill by signing it, he becomes the acceptor and is legally bound to make the payment on the due date.

Example

Suppose A (drawer) sells goods worth ₹50,000 to B (drawee). A draws a bill of exchange ordering B to pay ₹50,000 to A or his order after three months.

• Drawer: A (who makes the bill)
• Drawee/Acceptor: B (who accepts to pay)
• Payee: A or any person to whom A transfers the bill

If B accepts and signs the bill, it becomes a valid bill of exchange.

Characteristics of a Bill of Exchange

1. Written Instrument: It must be in writing; oral promises are not recognised.
2. Unconditional Order: The order to pay must be absolute and not contingent upon any event or condition.
3. Definite Amount: The sum payable must be certain and clearly stated.
4. Specified Parties: The names of the drawer, drawee, and payee must be clearly mentioned.
5. Signed by Drawer: The bill must bear the signature of the person issuing it.
6. Payable in Money Only: The bill must involve payment in legal currency, not in goods or services.
7. Time of Payment: It may be payable on demand or at a fixed/future date.
8. Transferability: It is a negotiable instrument, meaning it can be transferred by endorsement and delivery, making it valuable in commerce.

Types of Bills of Exchange

1. Inland Bill: A bill drawn and payable within the same country. Example: A bill drawn in Mumbai and payable in Delhi.
2. Foreign Bill: A bill drawn in one country and payable in another. Example: A bill drawn in India and payable in London.
3. Time Bill (Usance Bill): Payable after a certain period from the date of drawing or acceptance (e.g., 90 days after date).
4. Demand Bill (Sight Bill): Payable immediately on presentation, without any specified period.
5. Trade Bill: Drawn to settle genuine trade transactions between a buyer and a seller.
6. Accommodation Bill: Drawn and accepted not against a trade transaction but to help another party raise money temporarily.
7. Clean Bill: A bill not backed by any security or supporting documents.
8. Documentary Bill: Accompanied by shipping or trade documents such as invoices, bills of lading, or insurance certificates.

Important Terms Related to a Bill of Exchange

• Drawer: The person issuing the bill.
• Drawee: The person ordered to pay.
• Acceptor: The drawee who agrees to pay by signing the bill.
• Payee: The person entitled to receive payment.
• Holder: The person in possession of the bill who is entitled to receive payment.
• Endorsement: The act of signing and transferring a bill to another party.
• Maturity: The date on which payment of the bill becomes due.
• Days of Grace: In time bills, an additional three days beyond the due date allowed to the drawee for payment.

Functions and Uses

1. Facilitates Credit Transactions: Enables the seller to extend credit to the buyer while retaining a legally enforceable claim.
2. Acts as a Negotiable Instrument: Can be endorsed or discounted with a bank, thus providing liquidity.
3. Proof of Debt: Serves as written evidence of a debt, enforceable in a court of law.
4. Basis for Discounting and Rediscounting: Banks often discount bills of exchange before maturity, providing instant cash to the holder.
5. Promotes Commercial Confidence: Standardised and legally recognised, it promotes trust in business transactions.

Example of a Bill of Exchange Format

₹50,000
Mumbai, 1 March 2025

Three months after date, pay to me or my order the sum of Rupees Fifty Thousand only for value received.

To,
Mr. B (Drawee)
Delhi

(Signed) A (Drawer)

Upon acceptance by B, the bill becomes legally binding and enforceable.

Advantages of Using a Bill of Exchange

• Provides written proof of obligation.
• Reduces the need for immediate cash payment.
• Enhances financial flexibility for businesses.
• Can be used as a collateral or negotiable instrument for obtaining loans.
• Minimises disputes through clear terms of payment.

Dishonour of a Bill of Exchange

A bill is said to be dishonoured when the drawee refuses to accept or pay it upon presentation. In such cases:

• The holder can issue a notice of dishonour to all prior parties.
• A noting or protest may be made by a notary public as formal evidence of dishonour.
• Legal proceedings can be initiated to recover the amount due.

Difference Between Bill of Exchange and Promissory Note

Legal and Economic Importance

The bill of exchange has been central to the development of modern commerce and banking. It serves as both a credit instrument and a means of payment, reducing reliance on physical currency. In international trade, bills of exchange facilitate cross-border transactions by providing a reliable framework for deferred payments.
In India and globally, such instruments underpin the structure of commercial law, ensuring that business transactions are conducted smoothly, transparently, and with legal assurance.