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Difference between promissory note and bill of exchange

April 11, 2022

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This article has been written by Debatree Banerjee from KIIT School of Law, Odisha. Negotiable Instruments are essential documents playing an essential role in the business realm. They embody a right to the payment of money and can be transferred from one person to another. This article broadly discusses negotiable instruments, and the difference between promissory note and bill of exchange .

It has been published by Rachit Garg.

Table of Contents

Introduction

Goods are sold or bought, for cash or on credit. When goods are sold for cash, the payment is received immediately. However, the payment gets postponed to a future date, if the goods are sold on credit. In such cases, to avoid the possibility of delayed payment or default, an instrument of credit is drawn. This instrument ensures the payment by the debtor to the creditor according to the agreed conditions on the due date.

The negotiable instrument is a document embodying a right to the payment of money that can be transferred from person to person. As described by Justice Willis “ A negotiable instrument is one, the property in which is acquired by anyone who takes it bona fide and for value notwithstanding any defects of the title in the person from whom he took it”.

In India, the negotiable instruments are governed by the Negotiable Instruments Act of 1881. It operates subject to Section 31 of the Reserve Bank of India Act, 1934, which states that no person other than the Bank or as expressly authorized by this Act, the Central Government shall accept, draw, issue or make any bill of exchange, promissory note, hundi or engagement for the payment of money payable to bearer on demand. This Section also provides that no one apart from the Reserve Bank of India or the Central Government can make or issue a promissory note articulated to be payable or demanded or after a definite time.

Meaning of Negotiable Instruments

Negotiable Instruments are documents that embody a right to the payment of money and may be transferred from person to person. These instruments were developed with efforts to make credit instruments transferable i.e, creditors to meet their liabilities keep documents that proves somebody is in their debt. To illustrate, X has promised to pay Y a certain amount of money at a specified date, in the future that can be used by Y to pay his debt to Z. This ‘negotiability’ of instruments is possible with the development of numerous negotiable instruments.

Section 13(a) of the Negotiable Instruments Act, 1881 says that “A ‘negotiable instrument’ means a promissory note, bill of exchange or cheque payable either to order or to bearer.” Even though the Act mentions only three instruments – cheques, promissory notes, and bills of exchange, however, it does not exclude the possibility of other instruments satisfying the following primary conditions of negotiability:

The instrument can be freely transferable via delivery or by endorsement and by the customs of the trade.
The person obtaining it in good faith must get it free from all defects and must be entitled to recover money for the instrument in his own name.

Few of such negotiable instruments are share warrants, debenture warrants, and dividend warrants. Instruments like deposit receipts, bill of lading, postal orders, dock warrants etc., are not negotiable instruments as although they are transferable by delivery and endorsements, they do not give a better title to the transferee for value than the transferor.

Negotiation : analysis

Before discussing the characteristics, let us understand the term “negotiation” with respect to these instruments. Section 14 of the Negotiable Instrument Act 1881, states that an instrument is said to be negotiated when the instrument has been transferred to a person and constitutes such person as the ‘holder’. The main purpose of such transfer is to make the transferee of the instrument the holder thereof. Thus, it is the procedure by which a third party is made the holder of the instrument, giving him the possession and the entitlement to receive the sum of money in his own name.

The two essential conditions of negotiation are:

The instrument must be transferred to another person, and
The transfer must be made in such a manner as to constitute the transferee as the holder of the instrument.

Therefore, handing over an instrument to someone for safe custody does not amount to negotiation. Because the transfer was not made with the intention to pass the title.

There are two modes of negotiation:

Negotiation by delivery: This mode has been mentioned in Section 47 of the Act. In cases, where the instrument is payable to a bearer, it can be negotiated by delivery thereof.
Negotiation by endorsement and delivery: This mode is mentioned in Section 48 of the Act. An instrument payable to order can be negotiated only by endorsement and delivery. That means, unless the holder has signed his endorsement on the instrument and delivers it, the transferee does not constitute as the holder.

Characteristics of Negotiable Instruments

A negotiable instrument can be identified by the following characteristics:

Title

The person who is in possession of the negotiable instrument is considered to have the right to title over such instrument. Negotiable instruments can be transferred without any formality. A bearer instrument is transferred just by delivering it to the transferee, whereas an order instrument needs to be endorsed and delivered for transferring the instrument. The transferee of the negotiable instrument is known as ‘holder in due course’ as described in Section 9 of the Act. A bona fide transferee of value is not affected by any defect of title on the part of the transferor or any of the previous holders of the instrument.

Rights

The transferee of the negotiable instrument has the right to sue in his own name if the instruments get dishonoured. A negotiable instrument can be transferred multiple times till the date of its maturity. The holder of the instrument does not need to give any notice of its transfer to the party liable on the instrument to pay.

Presumption

There are a number of presumptions that apply to all negotiable instruments, for example, the presumption of consideration, time of acceptance, time of transfer, etc. These presumptions are presumed by the court in regard to negotiable instruments and do not need to be proved separately until the contrary is proved.

Presumptions as to Negotiable Instruments

As discussed above, in regard to negotiable instruments the court of law presumes certain presumptions, which do not need to be proved separately, until contrary following such presumptions is proved. The presumptions are as follows:

Consideration

It is presumed that every negotiable instrument drawn, accepted, or endorsed is for consideration. This presumption however may be rebutted, if proved that such instrument had been obtained by means of fraud or undue influence from its lawful owner.

Date

Until the contrary is proved, the date mentioned in the instrument is presumed to be drawn on such date.

Time of acceptance

In cases, where the date of acceptance is not dated, the instruments are presumed to be accepted within a reasonable time after its issue and before its maturity. Otherwise, where the date of acceptance is present, such date will be taken as prima facie evidence of the date on which it was made.

Time of transfer

It is presumed that a negotiable instrument was transferred before the date of its maturity.

Order of endorsement

It is presumed that the endorsements appearing upon a negotiable instrument were made in the order in which they appear.

Stamp

It is presumed that a lost instrument has been duly stamped according to the law.

Holder in due course

It is always presumed that the holder of the instrument is the holder in due course until otherwise has been proved.

Types of Negotiable Instruments

Section 13 of the Negotiable instruments Act recognises promissory notes, bills of exchange, and cheques as negotiable instruments. However, it does not exclude the possibility of other negotiable instruments. Hundis, share warrants, dividend warrants, circular notes, bearer debentures, etc., are examples of a few such instruments recognised by usage or custom.

The list of negotiable instruments mentioned above is not a closed chapter. With the continuous change in the commercial world, new kinds of securities may also get recognition as negotiable instruments.

Bill of exchange : meaning

Bill of Exchange is the most commonly used negotiable instrument and is also the most complex of all. Section 5 of The Negotiable Instrument Act, 1881 defines “bills of exchange” as a written instrument, signed by the maker, containing an unconditional order, and directing a certain person to pay an amount of money to a person or to the bearer of the instrument. In simple words, it is a document ordering a person addressed in the bill to pay a certain amount of money to someone else.

Features of a bill of exchange

The features of a bill of exchange as derived from the definition are:

It must be a written document.
It is an order to make payments.
The order to make the payment must be unconditional.
The bill of exchange must be signed by the maker.
The payment to be made should be certain.
The date on which the due payment must be made should also be certain.
The bill of exchange must be made to a certain person.
The amount to be paid is payable either on-demand or on the expiry of the time mentioned in the draft.
The draft must be stamped as per the legal requirements.

It is usually drawn by the creditors (drawer) upon their debtors (drawee) to ensure their payment on the due date. The bill of exchange must be accepted by the drawee, as it is just a draft without such acceptance.

Parties to a bill of exchange

There are three parties to a bill of exchange:

‘Drawer’ is the person who makes the bill of exchange. Generally, a seller/ creditor who is entitled to receive an amount of money from the debtor draws a bill of exchange upon the buyer/ debtor. The drawer must sign the bill of exchange, as its maker after writing it.
‘Drawee’ is the person upon whom the bill of exchange has been drawn, and is directed to pay a sum of money. They are usually the buyer/ debtor of goods.
‘Payee’ is the person to whom the drawee must pay the sum of money. In general, the drawer himself is the payee, if the bill is with him till the period of its payment. However, the payee may change in certain situations:

If the drawer is getting the bill discounted, the person discounting the bill will be the payee; and
if the drawer has endorsed the bill in favour of its creditor, then the creditor will become the payee.

Let us understand this with an illustration. Seeta sold goods to Geeta on credit, worth Rs 8,000. Seeta drew a bill of exchange upon Geeta for the payment of the due amount after three months. The bill of exchange will only be a draft unless Geeta accepts it by writing the word ‘accepted’ on it and apprehending her sign thereto communicating her acceptance. Here Seeta is the drawer and Geeta is the drawee. If Seeta retains the bill of exchange for the period of three months and receives the amount of Rs. 8,000 on the due date, then Seeta is the payee. And if Seeta gives away the bill to her creditor Raghav, then Raghav will be the payee. In case, Seeta gets the bill discounted from the bank, the bankers will become the payee.

In the above case, as Geeta accepted the bill of exchange, she will be the acceptor. And in her place, suppose Aditya accepts the bill, then Aditya will be considered as the ‘acceptor’.

Advantages of a bill of exchange

The bills of exchange are most frequently used in business transactions because of the following advantages:

Framework for relationships

The bills of exchange provide a framework that enables the credit transactions between the seller and buyer, or debtor and creditor on an agreed basis.

Certainty of terms and conditions

There is a certainty of time as the creditor is aware of the time when he would receive the amount, and similarly, the debtor is also aware of the date by which he has to pay the due amount. This is because the bill of exchange mentions the terms and conditions of the relationship between the debtor and creditor such as the due amount, date of payment, interest to be paid if any, and the place of payment, etc.

Convenient means of credit

A bill of exchange enables the buyer to buy goods on credit and pay after the period of credit. And, the seller can also get the payment immediately, even after the extension of credit, by getting the bills discounted with a bank or by endorsing it to a third party.

Conclusive proof

These bills are legal evidence of credit transactions implying that a trade buyer has obtained credit from the seller of goods, and he is liable to pay to the seller. In case the debtor refuses to make the payment, the law requires the creditor to obtain a certificate from the notary as conclusive evidence of its happening.

Easy transferability

With the bills of exchange, debt can be settled easily by transferring them through endorsement and delivery.

Promissory note : meaning

Section 4 of the Negotiable Instrument Act, 1881 defines ‘promissory note’. And as per the provision, it is a written instrument, which is not a banknote or a currency note, containing unconditional undertaking, and is signed by its maker to make payment of a certain sum of money to a certain person or to the bearer of the instrument. In simple words, it is a promise in writing by a person, to pay a certain amount of money unconditionally to a certain person or according to his order.

Features of a promissory note

The features of the promissory note as derived from the definition are:

The undertaking must be in writing.
The promise to pay must be unconditional.
The sum payable must be certain.
The promissory note must be signed by the maker.
It must be payable to a certain person.
It must be properly stamped.
As the maker of the promissory note himself is promising to pay the amount, it does not require any acceptance.

Parties to a promissory note

There are two parties to a promissory note:

‘Drawer’ is the person who is making the promissory note about paying the certain sum of money as specified in it. He is also called the ‘promisor’.
‘Drawee’ or ‘payee’ is the person in whose favour the promissory note has been drawn, and to whom the drawer must pay the money. He is also called the ‘promisee’. In general, the drawee is also the payee, unless it is mentioned otherwise in the promissory note.

Let us understand this with an illustration. Ram is the drawer who promised to pay a sum of Rs. 10,000 to Priya, the drawee or payee. If Priya endorses this promissory note in favour of Akshay, then Akshay will become the payee. Similarly, if Priya gets the promissory note discounted from the bank, then the bank will become the payee.

Advantages of a promissory note

The advantages of a promissory note are similar to the advantages of bills of exchange, and they are as follows:

Identification

The promissory note contains the key details of the credit arrangement, including the amount due to be paid and the due date for such payment. It also contains the identification of both the lender and the borrower by their name. And in case, if the lender needs interest over the due amount, such an interest rate is also mentioned in the note.

Clarity regarding default terms

Another advantage of a promissory note is that it clearly mentions all the terms and conditions, including the terms in case of default of payment to prevent unnecessary confusion and disputes.

Use the note in the courts of law

On a promissory note, the credit is properly documented and thus, can be used as evidence while seeking a judgment in court if any conflict arises between the debtor and the creditor.

Difference between bill of exchange and promissory note

The bills of exchange and promissory notes, both are instruments of credit and similar in many ways. However, they have basic differences from as mentioned below:

The number of parties

In the case of a bill of exchange, there are three parties – the drawer, the drawee, and the payee. Whereas there are two parties in the case of promissory note – the drawer and the drawee.

Payment to the maker

In the bill of exchange, the drawer and the payee may be the same person. However, in the case of a promissory note, the drawer can never be the payee.

Unconditional promise

The bill of exchange contains an unconditional order for the drawee to pay the payee according to the direction of the order, whereas a promissory note contains an unconditional promise by the drawer to pay the payee.

Prior acceptance

In the case of a promissory note, the liability of the drawer is primary and absolute, but for a bill of exchange, the liability is secondary and conditional.

Relation

The drawer of promissory note stands in immediate relation with the payee, while the drawer of an accepted bill of exchange stands in relation with the acceptor.

Conclusion

Negotiable instruments play a major role in business transactions, and they are used in both domestic and international trades. These instruments become negotiable by statutory provisions or through mercantile usage. Promissory notes and bills of exchange are two of such negotiable instruments that are mentioned in The Negotiable Instruments Act. And these two are different from each other for their different features.

Bills of exchange is a written document showing the indebtedness of the debtor towards the creditor. It is the creditor who makes the bill of exchange. Whereas, a promissory note is a written promise by the debtor, to pay the specified amount of money on a specified date. These instruments are easily transferable, and the holder of the instrument can take the amount, or use it for another transaction in an appropriate manner.

Negotiable Instruments are significant for both domestic and international transactions by providing a very safe and secured system for monetary transactions, as one does not always have to carry a large sum of money with themselves to pay the other.

References

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