Bill of exchange

Businesses have long needed a way to order someone to pay money to a third party, without physical cash changing hands at every step. The Negotiable Instruments Act, 1881, gives legal recognition to three such written instruments: the promissory note, the bill of exchange, and the cheque.

A bill of exchange is the middle one of the three. It is a written, signed order, not a promise, from one person, directing another person to pay a fixed sum to a named person or to the bearer.

Section 5 of the Negotiable Instruments Act, 1881, defines a bill of exchange as a written, signed 'unconditional order' directing a person to pay a fixed sum to a named person or to the bearer.

A cheque, defined separately under Section 6, is in fact a specific type of bill of exchange, one drawn on a specified banker and payable on demand, including its electronic image and electronic form. Together with the promissory note, all three are classed as negotiable instruments under Section 13, meaning they can be transferred by delivery or endorsement, either payable to order or to bearer.

A textile trader in Surat sells goods worth Rs 5,00,000 to a buyer in Delhi. Instead of the buyer paying immediately, the trader draws a bill of exchange, ordering the buyer to pay Rs 5,00,000 to the trader, or to the trader's order, 90 days later.

If the buyer signs the bill accepting the order, it becomes an accepted bill of exchange, a legally enforceable instrument. The trader can then hold it to collect the money after 90 days, or transfer it to someone else, such as a bank, at a discount, before then, since it is a negotiable instrument, just as a cheque or promissory note would be.

Chapter 18 (Key Regulations), section 18.8.4, 'Negotiable Instruments Act, 1881', gives the Section 5 definition of a bill of exchange, distinguishes it from the promissory note, Section 4, and the cheque, Section 6, and covers negotiation, dishonour and penalties for these instruments. Expect a question that asks you to identify a bill of exchange from its features, or that distinguishes it from a cheque or a promissory note.

• A bill of exchange is an order to pay, signed by the person giving the order, the maker; a promissory note is instead an undertaking to pay, signed by the person who owes the money — the direction of the instrument is opposite.
• A cheque is legally a bill of exchange with two extra conditions: it must be drawn on a banker, and it must be payable on demand — every cheque is a bill of exchange, but not every bill of exchange is a cheque.
• 'Unconditional' matters: an order to pay only if some condition is met is not a valid bill of exchange under Section 5.