What is a bill of exchange? — Definition
A bill of exchange is a written, signed instruction by one party directing another party to pay a specific sum to a third party either on demand or at a set future date. It is a negotiable instrument (transferable by endorsement) commonly used to arrange payment in commercial and international trade.
Key parties and terms (defined)
– Drawer: the party that creates and signs the bill, ordering payment.
– Drawee: the party ordered to pay (typically the buyer or the buyer’s bank).
– Payee: the party who will receive the money.
– Acceptance: the drawee’s written agreement on the bill acknowledging the obligation to pay; a bill generally must be accepted to be enforceable.
– Usance: the time period agreed between billing and payment (for example, 30, 60, 90 days).
– Endorsement: a signature on the back that transfers the bill to another holder.
– Negotiable instrument: a transferable written document that promises or orders payment of money.
How a bill of exchange works — step by step
1. Seller (drawer) issues a bill of exchange that names the drawee, payee, amount, and due date.
2. Seller ships goods or provides services according to the sales contract.
3. Drawee accepts the bill (writes “accepted” and signs), acknowledging the debt and promising to pay on the due date.
4. At maturity, the holder (payee or an endorsed transferee) presents the bill for payment.
5. If needed earlier, the holder can sell (discount) the accepted bill to a bank for cash before maturity.
Why businesses use bills of exchange
– They create a clear, transferable record of indebtedness.
– They let sellers extend credit (usance) while preserving a negotiable claim that can be endorsed or discounted.
– In cross-border trade, they help manage payment timing and provide a standardized instrument recognized under many legal systems.
Differences vs. related instruments
– Check: normally payable on demand and drawn against a bank; a bill of exchange can be payable on demand or at a future date and is typically used in commercial credit arrangements.
– Promissory note: a promise by one party to pay another (maker to pay payee). A promissory note is created by the debtor; a bill of exchange is created by the creditor ordering a third party to pay. Promissory notes are usually not made out to a third-party drawee in the same way.
Checklist — what to include and verify on a bill of exchange
– Clear principal amount (currency specified).
– Name of drawee and payee.
– Payment terms: on demand or fixed maturity date (usance).
– Place and date of issue.
– Drawer’s signature.
– Acceptance by drawee (if payment will be deferred).
– Any agreed interest rate or late-payment terms (if applicable).
– Endorsement line if intended to be transferable.
– Keep copies and document the underlying sales contract and shipment evidence.
Small worked example
– Scenario: Car Supply XYZ sells parts to Company ABC for $25,000, with payment in 90 days.
– Step 1: Car Supply (drawer/payee) draws a bill of exchange on Company ABC (drawee) reading “Pay to Car Supply XYZ $25,000 on 90 days after sight.”
– Step 2: Company ABC accepts the bill by signing it; goods are shipped.
– Step 3 (maturity): 90 days after acceptance, Car Supply presents the accepted bill to Company ABC and receives $25,000.
– Alternative: Car Supply can endorse and discount the accepted bill at a bank prior to maturity to receive immediate cash at a small fee.
Practical notes and limitations
– A bill of exchange is not itself the underlying sales contract; it evidences the payment obligation and can be used to satisfy contract terms.
– Unless interest is specified, bills typically do not carry interest; parties must state any interest rate for overdue payment.
– Legal enforceability and formal requirements vary by jurisdiction; acceptance and signature rules are important for negotiability and remedies.
When bills of exchange are especially useful
– Cross-border sales where parties require a standardized, transferable payment instrument.
– Situations where the seller wants to give the buyer time to pay but wants a negotiable asset that can be endorsed or discounted.
– Trade transactions involving multiple parties or where banks will be intermediaries.
Selected authoritative sources
– Investopedia — Bill of Exchange: https://www.investopedia.com/terms/b/billofexchange.asp
– UNCITRAL — 1930 Convention on Bills of Exchange and Promissory Notes: https://uncitral.un.org/en/texts/payments/1930-bills_of_exchange_promissory_notes
– Cornell Law School, Legal Information Institute — UCC Article 3 (Negotiable Instruments): https://www.law.cornell.edu/ucc/3
– International Chamber of Commerce (ICC) — Uniform Rules for Collections (URC 522): https://iccwbo.org/publication/uniform-rules-for-collections-urc-522/
Educational disclaimer
This explainer is for educational purposes only and does not constitute legal, tax, or investment advice. For guidance tailored to your circumstances, consult a qualified professional.