This article has been written by Priyanka Jain. It dives deep into the concept of bill of exchange under Section 5 of the Negotiable Instruments Act, 1881. The article explores the meaning, essential ingredients, features, and types of bill of exchange. It also distinguishes bills of exchange from other negotiable instruments like cheques and promissory notes, highlighting their relevance in the modern mercantile landscape.
Table of Contents
Introduction
In the dynamic world of economic transactions, nearly every moment is fueled by some kind of financial transaction or exchange of money. From the morning cup of tea and the daily newspaper to groceries and electronics, and from birth to death, everything requires money to be carried out effectively. In other words, money is the lifeblood that keeps everything running. Therefore, in order to facilitate these transactions or exchanges, we rely on specific tools or documents known as negotiable instruments. These instruments serve as a promise that a certain payment will be made to a specified person, allowing the holder to receive funds in cash or transfer them to any other person.
There are three types of negotiable instruments: promissory notes, cheques, and bills of exchange. This article focuses on the bill of exchange, an important financial document for not only domestic but also international scenarios. Section 5 of the Negotiable Instruments Act, 1881 defines ‘bill of exchange’ and highlights its significance. It also discusses the essential compliances necessary to make it enforceable, such as being in writing, signed by the maker, and being unconditional, among others. This article delves into the meaning of ‘bill of exchange,’ its essential ingredients, legal machinery, its distinction from other negotiable instruments, and its practical use in both national as well as cross-border transactions.
Section 5 of Negotiable Instruments Act
Section 5 of the Negotiable Instruments (NI) Act, 1881, defines a ‘bill of exchange’. In general terms, a ‘bill of exchange’ is understood as a type of negotiable instrument. It is a written agreement between a drawer and a drawee. Initially and widely used in international markets, it states that the drawee has agreed to pay a certain sum of money to the payee in lieu of the goods or services provided. A bill of exchange is an order to pay. It is a written negotiable instrument that contains an unconditional order to pay a specified amount to the holder of the instrument, as written by the maker of the bill of exchange. In a bill of exchange, the maker/drawer directs another person (the drawee) to pay the ordered amount to the specified person (the payee).
According to Section 5, a ‘bill of exchange’ is an instrument in writing that consists of an unconditional order to pay a specified amount. This is an instrument where one person directs another person to pay the amount of money specified in the ‘bill of exchange’. As specified above, this order must be unconditional and signed by the person making the request. The payment can be made either to a named person, to someone they choose, or to anyone who holds the document.
Features of a bill of exchange
A bill of exchange is a financial document issued by a creditor or beneficiary directing a debtor or buyer in the course of business to pay a fixed amount within a specific time period. The document should be clearly titled ‘bill of exchange’ which should be written on the top of the document. It should also include a unique identification number.
Following are some of the features of a bill of exchange:
- It should be in writing;
- It must include an unconditional order to pay;
- It must be signed by the maker;
- It can be an order instrument or a bearer instrument;
- The sum payable must be ‘certain,’ i.e., it must be clearly stated in both words and in numerals;
- The parties to the bill of exchange should be certain. One party can act as both the drawer and the payee. According to the Section 31 of the Reserve Bank of India Act, 1934, in no case can the bill of exchange be made payable to bearer on demand;
- The document must specify the agreed timeline for payment;
- It should be duly signed.
Essential ingredients
As per the language of Section 5, there are several crucial key terms that form the basis of a bill of exchange. These are its essential ingredients, which are basically conditions that must be fulfilled for a negotiable instrument to be defined as a bill of exchange. These essential ingredients are as follows:
- Written instrument: The bill of exchange must be an instrument in writing that includes an order of payment.
- Unconditional order: The order must be unconditional in the sense that it directs the payment of a certain amount of money to the relevant person without any additional conditions. The payment is to be made without any further conditions, paperwork, or additional actions. For example, the person in possession of the instrument cannot compel the person who has to pay the specified amount to perform any additional actions like obtaining a No Objection Certificate (NOC), clearing TDS, or paying further surcharges.
Further, as per the proviso, if the payment or any part of the payment is due after a certain period following the occurrence of an event that is expected by everyone to happen, regardless of the exact timing, then it is not considered a conditional bill of exchange. For instance, if the bill of exchange states, ‘Pay Mr. Alex Rs. 5,00,000/- thirty days after the arrival of 1,000 units of pharmaceutical gloves at the Kandla Port,’ it remains unconditional. Although the exact time of arrival is uncertain, the arrival of 1,000 units of pharmaceutical gloves at the Kandla Port is certain. The payment is due after the completion of thirty days.
- Certain person: The term ‘certain person’ as mentioned in this Section and Section 4 refers to the intended recipient of the payment, even if identified by description rather than name, or if their name is misspelt. This term has two meanings:
- The person to whom the payment is directed. This could be the person named on the instrument or a third party.
- The person who has the obligation to make the payment as specified in the bill of exchange.
On a reading of the proviso to Section 5, it becomes evident that the Section clearly states that if the name of the person is misspelt or if they are directed by way of a description, such as ‘manager,’ and it is clear who should receive the money, then the person so directed is considered a ‘certain’ person.
- Bearer of the instrument: A bearer is any person who holds the bill of exchange, regardless of whether their name is specified. They can demand payment from the person directed to pay.
- Signed: The instrument must be signed by the maker.
- Certain sum: The amount to be paid is considered certain even if it includes future interest or is payable at an indicated exchange rate. In the event of a default in payment, meaning that if one payment is missed, the unpaid balance becomes due immediately.
Parties to a bill of exchange
A bill of exchange primarily involves the following three parties, as per Section 7:
- Drawer: The drawer is the party who creates the instrument, i.e., the bill of exchange. They specify the amount to be paid, the date of payment, and the person who will receive the payment.
- Drawee: The drawee is the person or entity on whom the bill of exchange is drawn. They are directed to make the payment. When the drawee accepts the bill of exchange, they become the acceptor and are legally obligated to pay the specified amount.
- Payee: The payee is the person named in the bill of exchange who will receive the payment once the bill of exchange is executed.
Typically, a bill of exchange involves these three parties. The drawer and payee are often the same person, unless the drawer transfers the bill to a third party. In such cases, the third party becomes the payee. The drawer is responsible for binding the drawee to make the payment to the payee.
In addition to these primary parties, other roles can be involved in the course of business transactions, which are as follows:
- Endorser: The endorser is the person who transfers their right to receive payment to another party by endorsing the bill of exchange.
- Endorsee: The endorsee is the person to whom the bill of exchange is transferred by the endorser and who now holds the right to receive payment.
- Bearer: The bearer is the person who holds the bill of exchange and can demand payment, even if their name is not specified.
Examples of a bill of exchange
Bank draft
A bank draft, also known as a demand draft, is a type of bill of exchange where a bank is the drawer and instructs another bank or its branch to pay a specified sum to the payee. It is used in those business transactions where the payee requires a guarantee of payment for huge transactions to avoid risks.
Trade draft
Trade is the buying and selling of goods. A trade draft is a bill of exchange drawn by a seller (the drawer) on a buyer (the drawee) for the payment of goods or services sold. It is commonly used in both domestic and international trade. It ensures that the seller receives payment after delivering the goods or services.
Sight draft
A sight draft is a bill of exchange that is payable immediately upon sight or presentation to the drawee. It does not specify a future date for payment and is commonly used when the drawer requires immediate payment upon the draft’s presentation. This is often in shipping transactions where payment is required upon delivery. This definition aligns with Section 21 of the Negotiable Instruments Act, which states that the expression ‘at sight’ means the instrument is payable on demand.
Kinds of bill of exchange
The term ‘kinds of bill of exchange’ refers to classifications based on essential characteristics and the conditions under which they are issued and paid. These classifications help determine the primary purpose and usage of a bill of exchange. Key factors include timing, nature of transaction, location, payment, and associated documentation to determine the primary purpose of the bill of exchange.
In other words, different kinds of bill of exchange focus on broader classifications based on various factors, which are as follows:
- Time of payment: This classification is based on when the bill of exchange is payable. For example, if a bill of exchange is drawn on June 1, 2024 and is payable one month later, the payment date would be July 1, 2024. However, it must be noted that the payment date may be subject to grace periods or public holidays.
- Place of making or drawing and place of payment: This classification concerns whether the bill of exchange is to be paid at the place where it was drawn or at a different location, including foreign countries.
- Transaction: This classification is based on the nature of the underlying transaction, It can involve the sale of goods or services, or it may be used to provide financial support to the drawee. The bill of exchange may not always involve an immediate exchange of goods or services but may be used to enhance the drawee’s credits.
- Documentation: This classification considers whether the bill of exchange is accompanied by supporting documents such as bill of lading or invoice. It can be further divided into ‘document against acceptance’ and ‘document against payment’.
- Demand: This classification is used when a bill of exchange is payable only upon presentation and does not have a fixed date of payment. The Government of India and the Reserve Bank of India are the only ones authorised to issue bills of exchange that are payable on demand.
- Supply: This classification is widely used in governmental transactions where goods are supplied to the government by a supplier or contractor.
Types of bill of exchange
The following are the types of bill of exchange, categorised based on specific conditions and uses:
- Sight Bill: Payment becomes due immediately upon presentation of the bill of exchange.
- Time Bill (or Usance Bill): Payment is due at a future date specified on the bill of exchange.
- Inland Bill: The place of drawing and the place of payment are the same.
- Foreign Bill: The place of drawing is different from the place of payment, often involving different countries.
- Documentary Bill: The bill of exchange is accompanied by supporting documents like invoices, bills of lading, etc.
- Clean Bill: Unlike a documentary bill, it is not accompanied by supporting documents.
- Trade Bill: Bill of exchange drawn between a buyer and a seller during the course of trade to ensure payment for goods so purchased.
- Accommodation Bil: As the name itself suggests, it is a bill of exchange used to provide financial support or accommodation, often to assist the drawee’s credit.
- Supply Bill: It is often used in governmental transactions to ensure payments for goods supplied, typically drawn by the suppliers.
Practical importance of a bill of exchange
The bill of exchange is used in international trade to reduce the risk of non-payment. In the international market, there are differences in currencies, exchange rates, and mercantile laws; hence, it helps both the buyer and the seller to cope with these disparities. It is called a bill of exchange because it is used in the exchange of goods for money. It indicates the safe and secure handling of money. It can be used to provide loans, purchase goods, collect funds, etc.
Endorsement: One of the most distinctive traits of a bill of exchange is its endorsement. The word endorsement is derived from the French word ‘endosser,’ which means ‘to put on the back’. Since the transfer of the bill of exchange from one person to another is noted on the back of the bill of exchange, the procedure is called endorsement. However, in exceptional situations, the endorsement may be written on the front of the bill of exchange. The endorsement transfers all the rights arising from the bill of exchange. Endorsement can be ‘in blank,’ i.e., only with the signature of the endorser, or ‘in full’ with the description.
Escompt by: This term is of French origin and literally means ‘to discount’. Ordinarily, the bill of exchange has to be paid after the expiry of a certain maturity period. However, the holder may choose to sell or pay before maturity. Thus, the bill of exchange becomes a means for ‘escompted by,’ also known as ‘discounting’ in India.
The bill of exchange plays a major role in the commodity market as a substitute for money. It serves as a means for credit, payment, and pre-maturity payment. By understanding its practical aspects, entities can effectively manage their business operations while reducing potential risks.
Important legal framework under Negotiable Instruments Act, 1881
Following are the most important provisions regarding bills of exchange under the Negotiable Instruments Act, 1881:
- Section 26: This Section stipulates that to make, draw, accept, endorse, deliver, and negotiate a bill of exchange, a person must be capable of contracting under the prevailing law of contract. However, a minor (a person who has not reached the age of majority) can draw, endorse, deliver, and negotiate a bill of exchange but cannot be bound by it himself.
- Section 27: This Section specifies that an agent of the drawer cannot accept or endorse a bill of exchange in a manner that binds the principal unless the agent has been duly authorised to do so. A general authority to handle business or manage debts does not automatically grant the power to accept or endorse bills of exchange.
- Section 30: This Section states that it is the duty of the drawer of a bill of exchange to compensate the holder in case the drawee of acceptor dishonours the bill of exchange, provided that the drawer has been given or has received due notice of dishonour.
- Section 33: This Section states that only the drawee of a bill of exchange, or any of several drawees named,or a person designated as a drawee in case of need, or an acceptor for honour, can accept the bill of exchange. No other person can bind themselves through acceptance.
Important precedents surrounding Section 5 of Negotiable Instruments Act
Punjab & Sindh Bank vs. Vinkar Sahakari Bank Ltd. (2001)
In this case, the Supreme Court discussed bills of exchange apart from clarifying the position of a ‘pay order’. The Court opined that the key element of a bill of exchange is that it involves directing a certain person to pay a specified amount. It further emphasised that the requirement in Section 5 that a bill of exchange must direct a certain person to pay does not necessarily imply a third party; it can refer to the bank itself, which issues the pay order.
Ashok Yeshwant Badave vs. Surendra Madhavrao Nighojakar (2001)
In this case, the Apex Court distinguished between a bill of exchange and a cheque in the following words. The Hon’ble Supreme Court held that from a bare perusal of Sections 5 and 6 of the Negotiable Instruments Act, 1881, it appears that a bill of exchange is a negotiable instrument in writing containing an instruction to a third party to pay a stated sum of money at a designated future date or on demand. On the other hand, a cheque is a bill of exchange drawn on a bank by the holder of an account, payable on demand. Under Section 6 of the Act, a cheque is also a bill of exchange but is drawn on a banker and payable on demand. However, a bill of exchange drawn on a banker but not payable on demand is not a cheque. The Court further emphasised that a post-dated cheque is not payable before the date mentioned and will become a cheque on the said date. Before that date, the post-dated cheque remains a bill of exchange.
Anil Kumar Sawhney vs. Gulshan Rai (1993)
In this case, the Hon’ble Supreme Court observed that under Section 6 of the Negotiable Instruments Act, 1881, a cheque is a bill of exchange drawn on a banker and payable on demand. A post-dated cheque is considered a bill of exchange when it is initially drawn. It only becomes a cheque when it is payable on demand, which occurs on or after its specified date. Therefore, before this date, it remains a bill of exchange.
Difference between a bill of exchange and a cheque
Following are the major points of distinction between a bill of exchange and a cheque:
| Bill of exchange | Cheque | |
| Definition: It is a written instrument containing an unconditional order, directing a certain person to pay a certain sum of money either to a designated person, to their order, or to the bearer of the instrument, and signed by the maker. | Definition: A cheque is a bill of exchange drawn on a specified banker and payable on demand. | |
| Parties involved: This typically involves three parties, the drawer (who makes the bill), the drawee (who is directed to pay), and the payee (who receives the payment). Sometimes, the drawee and payee may be the same person. | Parties involved: A cheque always has three parties, the drawer (who writes and signs the cheque), the drawee (the bank), and the payee (the person to whom the cheque is payable). | |
| Legal basis: Defined under Section 5 of the Negotiable Instruments Act, 1881. | Legal basis: Defined under Section 6 of the Negotiable Instruments Act, 1881. | |
| Usage: It is used in commercial transactions to ensure payment for goods or services. | Usage: It is used for withdrawing money from the bank or making payments. | |
| Payment terms: It is payable on demand or after a specified period (time bills). | Payment terms: A cheque is always payable on demand. | |
| Drawing: It can be drawn on any person. However, a bill of exchange drawn on the bearer is only permitted by the Reserve Bank of India and the Government of India (for example., a bank note). | Drawing: A cheque is always drawn on a bank. | |
| Crossing and discounting: A bill of exchange cannot be crossed but can be discounted. | Crossing and discounting: It can be crossed to direct the bank to pay into a bank account and not directly over the counter, but it cannot be discounted. | |
| Validity: Its validity depends on the terms agreed upon by the parties involved. | Validity: A cheque has a specific validity period (e.g., three months from the date of issuance). | |
| Acceptance: A bill of exchange requires acceptance by the drawee to be valid. | Acceptance: A cheque does not require acceptance. | |
| Notice of dishonour: It requires formal notice of dishonour to be given to the drawer and any endorsers. | Notice of dishonour: No formal notice of dishonour is required for legal action; the cheque can be presented again. |
| Difference between a bill of exchange and promissory noteBill of exchangePromissory noteDefinition: A written instrument containing an unconditional order, signed by the drawer, directing a certain person/drawee/payee to pay a certain sum of money to a specified person or the bearer of the instrument.Definition: A written instrument containing an unconditional promise, signed by the maker, to pay a certain sum of money to a specified person or the bearer of the instrument.Parties involved: It involves three parties, the drawer (who creates the bill), the drawee (who is directed to pay), and the payee (who receives the payment).Parties involved: It involves two parties, the maker (who promises to pay) and the payee (who receives the payment).Nature of obligation: Contains an order to pay.Nature of obligation: Contains a promise to pay.Acceptance: It requires acceptance by the drawee to be enforceable.Acceptance: It does not require acceptance by the payee.Drawer and drawee: The drawer and the drawee are usually different persons. However, the drawee and payee may be the same person or different.Maker and drawee: The maker and drawee are the same person.Liability: The drawee is primarily liable upon acceptance.Liability: The maker is primarily liable.Use in trade: Often used in trade and business transactions, particularly in international trade, to facilitate credit.Use in Trade: Commonly used in personal loans and credit transactions, primarily in domestic settings.Transferability: It is easily transferable by endorsement and delivery.Transferability: It is transferable by endorsement or delivery.Dishonour: It can be dishonoured by non-acceptance or non-payment.Dishonour: It can only be dishonoured by non-payment.Notice of dishonour: Notice of dishonour must be given to all prior parties to hold them liable.Notice of dishonour: Notice of dishonour is not necessary to hold the maker liable. |
Conclusion
A bill of exchange is an important instrument in both domestic and international mercantile transactions. Simply put, it is a written promise to pay for goods or services. A post-dated cheque is a common example of a bill of exchange. It promotes various financial activities, including taking and repaying loans and ensuring payments. The essential features of a bill of exchange include that it must be in writing, signed by the maker, and contain an unconditional promise to pay a certain sum of money. These characteristics make it a reliable and trustworthy payment method. Its flexibility is enhanced by the ability to be discounted before maturity and endorsed further, which adds to its credibility.
Globally embraced, the bill of exchange is one of the most widely used instruments in facilitating international trade to mitigate the risk of non-payment and ensure that transactions are conducted smoothly. Trade finance, a critical aspect of global commerce, has traditionally relied on paper-based processes. However, with most mercantile activities now digitised, there is a pressing need to accept bills of exchange in electronic form. This change would streamline the process and significantly reduce time and cost.
Frequently Asked Questions (FAQs)
What is Section 5 of the Negotiable Instruments Act, 1881?
Section 5 of the Negotiable Instruments Act, 1881, defines a bill of exchange and lays down its essential ingredients.
A bill of exchange is defined under Section 5 of the Negotiable Instruments Act, 1881 as a written instrument containing an unconditional order, directing a certain person to pay a specified amount to the bearer of the instrument or a designated individual. This instrument must be signed by the maker.
What are the essential characteristics of a bill of exchange?
A bill of exchange has the following characteristics:
- It must be in writing and signed by the maker;
- It must be unconditional;
- It must order to pay a certain sum of money to a certain person;
- Such person may be a specified person or the bearer of the instrument;
- It can be payable either on demand or at a specific future date.
What is the difference between a bill of exchange and a cheque?
A bill of exchange is a written order to pay a certain sum of money to a specified person or bearer and can be payable on demand or at a future date. A cheque is a specific type of bill of exchange that is drawn on a bank and is payable on demand.
Whether a bill of exchange be payable to a drawer?
Yes, a bill of exchange can be payable to the drawer himself. This can be made by making the order of the drawer or to the bearer.
Who can make a bill of exchange a bearer instrument in India?
Only the Reserve Bank of India and the Government of India are allowed to draw a bill of exchange as a bearer instrument.
What is the historical reason for the usage of the bill of exchange in international trade?
Bill of exchange has facilitated the trade and financial transactions associated to trade and business as follows:
- It reduced the need of carrying large sum of money from place to place
- It reduced the risk of theft and loss
- It provided a reliable way of payment
- It provided with technological benefits like credit facility and deferred payments system among others
- Facilitated cross-border transaction in a massive way
References
- https://www.indiacode.nic.in/bitstream/123456789/15327/1/negotiable_instruments_act%2C_1881.pdf
- https://www.dripcapital.com/en-in/resources/blog/bill-of-exchange
- https://www.casemine.com/search/in/bill%2Bof%2Bexchange
- https://blog.ipleaders.in/difference-between-cheque-and-bill-of-exchange/
- https://www.researchgate.net/publication/305926602_The_bill_of_exchange_as_a_means_of_payment_and_security
- https://kjablr.kar.nic.in/assets/articles/Negotiable%20Instruments%20Act.pdf
