Legal Definitions - bill of exchange

A bill of exchange is a formal, written instruction from one party to another, ordering the payment of a specific, unconditional sum of money to a third party, either immediately upon presentation or on a predetermined future date. It acts as a transferable financial instrument, meaning the right to receive payment can be passed from one person or entity to another. While often used in international transactions, a similar instrument used primarily for domestic payments is sometimes referred to as a "draft."

Here are some examples to illustrate how a bill of exchange works:

• International Trade Scenario: An electronics distributor in the United States (the buyer) places a large order for components from a manufacturer in South Korea (the seller). The South Korean manufacturer wants assurance of payment before shipping the goods. The U.S. distributor's bank issues a bill of exchange, formally instructing itself to pay the South Korean manufacturer a specific amount of money on a set date, say 90 days after the components are shipped. This document provides the manufacturer with a guaranteed promise of payment, allowing them to proceed with the shipment confidently, knowing they will be paid even if the distributor faces financial difficulties later.

  How it illustrates the term: This is a written, unconditional order from the U.S. bank (acting on behalf of the distributor) to itself, promising a fixed sum to the South Korean manufacturer (the payee) on a predetermined future date. It facilitates international trade by providing payment security.

• Business-to-Business Credit: A small furniture maker purchases a significant quantity of specialized timber from a lumber supplier. The furniture maker needs 60 days to process the timber and sell the finished products before they can pay the supplier. To formalize this credit arrangement and provide the supplier with a secure asset, the furniture maker issues a bill of exchange. This document instructs their bank to pay the lumber supplier the agreed-upon amount exactly 60 days from the date of the timber delivery. The lumber supplier can then hold this bill until the due date or, if they need immediate cash, they could potentially sell it to a financial institution (like a factoring company) at a slight discount.

  How it illustrates the term: Here, the furniture maker (as the drawer, through their bank as the drawee) issues a written, unconditional order to pay a fixed sum to the lumber supplier (the payee) on a specific future date. It demonstrates the use of a bill of exchange to manage credit terms and its potential for transferability.

• Large-Scale Project Payment: A municipal government contracts with a construction company for a major infrastructure project. The contract specifies that a significant portion of the payment will be made six months after the project's completion, following a final inspection. To provide the construction company with a firm guarantee of this future payment, the municipal treasury issues a bill of exchange. This document is a formal instruction to the city's designated bank to pay the construction company a precise sum on a specific date six months from the project's certified completion. This allows the construction company to secure financing or manage its cash flow, knowing the payment is assured.

  How it illustrates the term: This example shows a government entity (through its bank) issuing a written, unconditional order to pay a fixed sum to the construction company (the payee) on a predetermined future date, providing a secure promise of payment for a large-scale project.