Bill of Exchange

A bill of exchange is a written order once used primarily in international trade that binds one party to pay a fixed sum of money to another party on demand or at a predetermined 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.

A bill of exchange transaction can involve up to three parties. The drawee is the party that pays the sum specified by the bill of exchange. The payee is the one who receives that sum. The drawer is the party that obliges the drawee to pay the payee. The drawer and the payee are the same entity unless the drawer transfers the bill of exchange to a third-party payee.

Unlike a check, however, a bill of exchange is a written document outlining a debtor's indebtedness to a creditor. It’s not payable on demand and is usually extended with credit terms, such as 90 days. As well, a bill of exchange must be accepted by the drawee to be valid.

Bills of exchange generally do not pay interest, making them in essence post-dated checks. They may accrue interest if not paid by a certain date, however, in which case the rate must be specified on the instrument. They can, conversely, be transferred at a discount before the date specified for payment.

If a bill of exchange is 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. If the funds are to be paid immediately or on demand, the bill of exchange is known as a sight bill, and if they are to be paid at a set date in the future, it is known as a term bill.

The difference between a promissory note and a bill of exchange is that the latter is transferable and can bind one party to pay a third party that was not involved in its creation. Bank notes are common forms of promissory notes. Bills of exchange orders a debtor to pay a particular amount within a given period of time—issued by the creditor. The promissory note is issued by the debtor and is a promise to pay a particular amount of money in a given period.

Company ABC purchases auto parts from Car Supply XYZ for $25,000. Car Supply XYZ draws a bill of exchange, becoming the drawer and payee in this case, for $25,000 payable in 90 days. Car Supply XYZ becomes the drawee and accepts the bill of exchange and the goods are shipped. In 90 days, Car Supply XYZ will present the bill of exchange to Company ABC for payment. The bill of exchange was an acknowledgment created by Car Supply XYZ, which was also the creditor in this case, to show the indebtedness of Company ABC, the debtor.

A bill of exchange must clearly detail the amount of money, the date, and the parties involved (including the drawer and drawee).