Types of Bills of Exchange

8/12/2019 Types of Bills of Exchange

1/9

Chapter Summary

A. FINANCING FOREIGN TRADE

This chapter examines both the mechanism of financing foreign trade and the sources offoreign trade financing. To understand international trade, one has to be familiar with the

documents, trade terms, and financing arrangements used in international sales.

International Trade Documents

The most important documents used in international trade are: (a) bills of lading, (b) bills of

exchange and promissory notes, and letters of credit.

B. BILLS OF LADING

The form and function of the bill of lading was discussed in Chapter 10.

C. BILLS OF EXCHANGE

bill of exchange is a written, dated, and signed instrument that contains an unconditional

order from the drawer that directs the drawee to pay a definite sum of money to a payee on

demand or at a specified future date. !t is an important tool in international trade because it is

a negotiable instrument, that is, an instrument that can be transferred free of most claims or

defenses that the drawer might ha"e. #egotiability ma$es a bill of exchange more readily

salable, and therefore a useful financial tool for raising money.

The Law Governing Bills of Exchange

There are three principal laws that go"ern most bills%of%exchange transactions in the world

today. These are: (1) the &nglishBills of Exchange Act('&) of 1 which is in force in the

*nited +ingdom and in "irtually all of 'ritains former colonies- () the Uniform Commercial

Code(*CC) which has been adopted in most of the *nited tates- and (/) the 1/0 Uniform

Law on Bills of Exchange and Promissory Notes(*') which has been adopted by most

&uropean countries. The first two of these are remar$ably similar % the merican *CC was

based on the &nglish '& % but the third, the *', is substantially different from the nglo%

merican rules.

Types of Bills of Exchange

The form that bills of exchange must ta$e depends on the go"erning law. The nglo%

merican laws re2uire only that a bill be in writing and be payable to order or to bearer. The

*' adds to this the re2uirements that a bill: (a) contain the term 3bill of exchange3 in the

body and language of the chec$, (b) state the place where the bill is drawn, (c) state the place

where payment is to be made, and (d) be dated.

'ills ta$e se"eral particular forms. These include 3time bills,3 which are payable at a definite

future time- 3sight bills3, which are payable on presentment or at a stated time after

presentment- 3trade acceptance,3 where the the drawer and the payee are the same person- and3chec$s,3 where the drawee is a ban$.


2/9

D. PROMISSORY NOTES

promissory note is a promise made by a ma$er to pay a determinate sum of money to a

payee. !t is not a bill of exchange because there is no third party drawee. !t is, howe"er,

go"erned by the same rules.

#otes are used in a "ariety of credit transactions and are commonly gi"en the name of the

transaction in"ol"ed. 3Collateral notes3 are secured by personal property- 3mortgage notes3

are secured by real property- 3installment notes3 are payable in installments- and 3certificates

of deposit3 are promises by a ban$ to repay money recei"ed.

E. NEGOTIABILITY OF BILLS AND NOTES

'ills of exchange and promissory notes may be either negotiable or nonnegotiable. 4owe"er,

for trade to run smoothly, especially international trade, these instruments need to be

negotiable. 5or a bill or note to be negotiable, it must (a) be in the proper form (as described

abo"e), and (b) contain a promise by the ma$er or drawer to ma$e payment. To meet the

promissory re2uirements, a bill or note must (1) state an unconditional promise or order to

pay, () state a definite sum of money or a monetary unit of account- (/) be payable on

demand or at a definite time, and (6) be signed by the ma$er or drawer.

Unconditional Promise or rder to Pay

5or a bill or note to be negotiable, it must contain an affirmati"e promise to pay made either

as promise by a ma$er or as an order by a drawer to a drawee. The promise may not be

implied. !t also may not be conditioned upon the performance of some other obligation.

4owe"er, mere reference to some other agreement (such as the fact that the ma$ersperformance is secured by a mortgage) does not ma$e a bill or note nonnegotiable.

Definite !um of "oney or "onetary Unit of #ccount

The *' specifies that the sum paid must be 3money3 (i.e., the currency of any go"ernment).

The common law allows for the sum paid to be money or a monetary unit of account (that is,

a money of account established by an intergo"ernmental institution or by agreement between

two or more states).

The sum must be 3certain,3 3determinate,3 or 3definite.3 !n other words, the amount to be paid

has to be ascertainable from the bill or note itself without reference to an outside source.

Paya$le on Demand or at a Definite Time

The time when a bill or note is payable has to be ascertainable from its face.

!igned $y the "a%er or Drawer

'ills of exchange must be signed by the drawer, and promissory notes by their ma$er.

signature is 3any symbol executed or adopted by a party with present intention to authenticate

a writing.3


3/9

F. THE NEGOTIATION AND TRANSFER OF BILLS AND NOTES

7nce a negotiable instrument circulates beyond the original parties, the laws go"erning

negotiation apply.

#ssignment

n assignment is the transfer of rights under a contract. 8hen an assignment is made, the

assignee ac2uires only those rights that the assignor possessed. dditionally, all ob9ections to

honoring the assigned obligations that could be raised against the assignor can be raised

against the assignee.

&egotiation

The negotiation of a bill or note is its transfer in such a way that the recipient becomes a

holder. *nli$e an assignee (who only ac2uires the rights of the assignor), a holder can ac2uire

more rights from the transferor than the transferor possessed. The rights which a holderac2uires depends on the manner in which the instrument was negotiated, and the go"erning

law.

'ills and notes which are 3order paper3 name the payee or endorsee who is to be paid. 7rder

paper is negotiated by deli"ery and endorsement. 'ills and notes which are 3bearer paper3 do

not designate a person to be paid (they are instead made out to 3bearer,3 or to 3cash,3 or are

endorsed without naming an endorsee). 'earer paper is negotiated by deli"ery alone.

8hen endorsements are added to a bill or note, they may be one of four $inds: (1) special

endorsements, () blan$ endorsements, (/) 2ualified endorsements, and (6) restricti"eendorsements. pecial endorsements name an endorsee to be paid- blan$ endorsements do

not. 2ualified endorsement states that the endorser does not guarantee that the instrument

will be accepted or paid. estricti"e endorsements limit the rights of subse2uent holders in

some way, such as conditioning payment on the occurrence of a specified e"ent, or ma$ing

the endorsee a collection agent, or ma$ing the instrument payable only to a particular person-

or re2uiring the endorsee to pay the proceeds to the endorser or to some third party.

'orged Endorsements

5orged endorsements are treated differently by each of the principal laws regulating bills and

notes. The *' ma$es a forged endorsement fully effecti"e, and both the person ta$ing aninstrument with such an endorsement, as well as all subse2uent holders, are entitled to

payment. The nglo%merican rules ma$e the person best able to pre"ent the forgery from

happening liable for payment. ;enerally, this is the endorsee, who is re2uired to $now who

the endorser is. There are two exceptions, howe"er. The drawer, ma$er, or endorser who

transfers an instrument to either an impostor or fictitious payee is liable for payment because

they were in a better position than the subse2uent endorsee to pre"ent the forgery.

Limitations on the Excuses that Drawers and "a%ers (an Use to #void Paying ff a

Bill or &ote

8hen a bill or note is properly negotiated, drawers and ma$ers must pay the personpresenting the instrument for payment. The excuses that drawers and ma$ers can use for not


4/9

paying nonnegotiable instruments are se"erally limited when an instrument is negotiable. The

most extensi"e limitations are those contained in the *'. nyone who ac2uires a bill or note

by negotiation is a holder who is entitled to payment from the ma$er or drawer. There are

only three excuses a"ailable to these parties: (1) that the possessor is not a holder because he

did not ac2uire title through an uninterrupted series of endorsements, () that the holder

ac2uired the instrument in bad faith, and (/) that the holder ac2uired the instrument throughgross negligence.

The nglo%merican rules impose, by contrast to the *', "ery few limitations on the

excuses that ma$ers and drawers can use to get out of their obligation to pay off a bill or note.

To a"oid these excuses, a possessor must first be a holder, that is, someone who ac2uired the

bill or note through an uninterrupted series of endorsements. person who is not a holder is

not entitled to the instrument and must gi"e it up.

8hen the possessor of a bill or note is an ordinary holder, a ma$er or drawer can draw upon a

lengthy list of excuses for not paying, including: breach of contract, failure of consideration,

incapacity, duress, fraud, forgery, material alteration, illegality and discharge in ban$ruptcy.The list is narrowed (to the last six items), howe"er, if the holder can pro"e that he is entitled

to the additional status of a holder in due course (4


5/9

account party that is intended to benefit a third party. The issuer is obliged to pay a bill of

exchange drawn by the account party, up to a certain sum of money, within a stated time

period and upon presentation by the beneficiary of documents designated by the account

party.

The function of the letter of credit in international sales transactions is to substitute the creditof a recogni=ed international ban$ for that of the buyer. !n such an underta$ing, the buyer is

the account party, the buyers ban$ is the issuing ban$, and the beneficiary is the seller.

Governing Law

The go"erning law for letter of credit transactions, e"en in most domestic transactions, is the

!nternational Chamber of Commerces Uniform Customs and Practices for Documentary

Credits (*C>). 8hile it is neither a treaty nor a legislati"e enactment, most ban$s incorporate

the *C> in the terms of the credits they issue.

#pplying for a Letter of (redit

The terms of a letter of credit are specified by the account party in an 3application3 which, if

accepted by the issuer, becomes the agreement go"erning the relationship not only of the

account party and issuer, but also the relationship between the issuer and the

beneficiary. 8hile a letter of credit does not ha"e to be in any particular form, it does need to

be (a) in writing, (b) signed by the issuer, and (c) complete and precise.

Documentary 'ormalities

etters of credit must also clearly indicate if they irre"ocable. hould there be any doubt,

credits will be interpreted as being re"ocable. They must additionally indicate when and how

they are to be paid. 5inally, they must also name the ban$ which is authori=ed to pay the

credit, to accept bills of exchange drawn in accordance with the letter, or to negotiate the

credit.

#dvising and (onfirming Letters of (redit

7nce a ban$ issues a letter of credit, it will commonly deli"er the instrument to a

correspondent ban$ located in the beneficiarys country, which will in turn deli"er the credit

to the beneficiary. This ban$ assumes no liability for paying the letter of credit. n issuingban$ may also re2uest another ban$ to confirm an irre"ocable letter of credit. confirmation

is an independent promise by a second ban$ that it will pay, accept, or negotiate a credit, as

appropriate, when the documents specified in the credit are presented to it and the other terms

and conditions of the credit ha"e been complied with.

The $ligations of Ban%s

n issuing ban$ or any ban$ that is re2uired to pay, accept, or negotiate a letter of credit is

obliged to do so solely on the basis of the documents presented by the beneficiary. s long as

the documents appear regular on their face, the ban$ must pay. ban$ is not to concern itself

with matters 3off the document,3 such as the condition of the goods in"ol"ed in theunderlying transaction, or e"en their existence.


6/9

!n determining whether the documents are in order, a ban$ is entitled to apply the so%called

3rule of strict compliance.3 !n other words, a ban$ may re9ect documents that do not exactly

comply with the terms specified in the letter of credit. s a practical matter, in cases where

only a minor discrepancy exists, ban$s will commonly obtain a written wai"er from the

account party. !f there is a ma9or discrepancy or if the seller is unable to perform as originally

agreed, ban$s will commonly arrange for the account party to ma$e an amendment.

'ecause ban$s are re2uired only to ta$e into consideration the documents presented by the

beneficiary, they are allowed to pay on a letter of credit e"en if they are aware that the

beneficiary has perpetrated a fraud on the account party. !n fact, most courts ha"e held that a

ban$ must pay in such a case, and is liable if it fails to do so.

*ights and *esponsi$ilities of the #ccount Party

The account partys rights and obligations are based on two contracts: (1) the underlying

contract with the beneficiary, and () the contract with the issuing ban$ relating to the letter of

credit. !ts rights under the first contract are determined by ordinary contract law. !ts rightsunder the second are limited by international practice.

The main limitation on an account partys rights under the contract with the issuing ban$ is the

doctrine of pri"ity. That is, because the account party is only in pri"ity with the issuing ban$,

it can only loo$ to the issuing ban$ for performance. The account party has no rights "is%?%"is

any other ban$.

*ights and *esponsi$ilities of Beneficiaries

The right of a beneficiary to collect on a letter of credit is based, not on contract, but on

commercial practice. &ssentially, to collect on the credit, a beneficiary must comply with its

terms and conditions of the credit and present to the issuer (or the issuers agent) the

documents designated in the credit.

H. FINANCING FOREIGN OPERATIONS

The money needed to finance a multinational enterprise can be raised from a "ariety of

sources, including the companys own internal funds. !nternal funds are not always enough,

howe"er, and companies in such cases turn to the worlds capital mar$ets and to go"ernmental

and intergo"ernmental in"estment and de"elopment programs.

Private !ources of (apital

>ri"ate sources of capital funding were discussed in Chapter .

Governmental !ources of (apital

;o"ernmental sources of capital can be found in both the host and the home country. @ost

host countries ha"e de"elopment ban$s that pro"ide low%interest%rate long%term loans to

foreign in"estors. @ost de"eloped countries ha"e a "ariety of agencies that finance imports

and exports. &xamples of *nited tates agencies include: the gency for !nternational

ri"ate !n"estment Corporation (7>!C), and the &xport%!mport 'an$.


7/9

*egional and International Development #gencies

'oth regional intergo"ernmental agencies as well as international agencies underwrite

multinational in"estments. egional de"elopment ban$s exist for frica, sia, &urope,

merica, and the !slamic countries.

The worlds de"elopment ban$ is the !nternational 'an$ for econstruction and


8/9

Time 'ill

Trade cceptance

Practice Questions

True+'alse

1. T 5 Trade documents are used in international trade because buyers and sellers are

separated both in distance and by the differing financial practices of their home

countries.

. T 5 bill of exchange is a two%party instrument. That is, it contains a promise from

a ma$er to pay a payee.

/. T 5 @a$ers and drawees of negotiable instruments (bills of exchange and

promissory notes) ha"e 3primary3 liability (that is, they must ma$e payment on

presentment of the instrument).

6. T 5 confirmed letter of credit allows for the bills of exchange designated in the

letter of credit to be negotiable at any ban$.B. T 5 n ad"ising ban$ is a ban$ that independently promises that it will pay, accept,

or negotiate a letter of credit when the documents specified in the credit are

presented to it and the other terms and conditions of the credit ha"e been

complied with.

"ultiple (hoice

. ccording to the Uniform Law on Bills of Exchange and Promissory Notes

(*') of 1/0, a bill of exchange must:

a. contain the term 3bill of exchange3 in the body of the instrument.b. contain the term 3bill of exchange3 in the language of the instrument.

c. state the place where the instrument was drawn.

d. ll of the abo"e.

e. 'oth a. and b. abo"e.

D. promissory note which is secured by personal property is $nown as aEan:

a. certificate of deposit.

b. collateral note.

c. installment note.

d. mortgage note.

e. #one of the abo"e.

. *nder which of the following laws is the drawer of a bill of exchange, after

paying a forged instrument, allowed to reco"er from the endorsee who too$ the

instrument from the forgerF

a. Convention on International Bills of Exchange and International Promissory

Notes (C!'#) of 1.

b.English Bills of Exchange Act ('&) of 1.

c. Uniform Law on Bills of Exchange and Promissory Notes (*') of 1/0.

d. United tates Uniform Commercial Code (*CC).

e. 'oth b. and c.

. *nder which of the following laws does the transferor of a negotiable


9/9

instrument ha"e 3warranty liability3F

a. Convention on International Bills of Exchange and International Promissory

Notes (C!'#) of 1.

b.English Bills of Exchange Act ('&) of 1.

c. Uniform Law on Bills of Exchange and Promissory Notes (*') of 1/0.

d. United tates Uniform Commercial Code (*CC).e. 'oth a. and d.

10. letter of credit obtained by a seller naming the buyer as the beneficiary is

called:

a. clean.

b. confirmed.

c. re"ol"ing.

d. standby.

e. #one of the abo"e.

Essay

11. eller has a confirmed letter of credit it recei"ed from 'uyer for the sale to 'uyer of 1,000

bales of ;rade cotton. The letter of credit re2uired eller to deli"er a carriers bill of lading

and a certificate of inspection to the confirming ban$ before the ban$ was allowed to pay on

the credit. The cotton that eller shipped was defecti"e and eller had to bribe the carrier in

order to obtain a clean bill of lading and the inspection ser"ice in order to get a satisfactory

certificate. 'ecause eller has a long%time relationship with the confirming ban$, eller told

the ban$ about the bribes. The confirming ban$, which was depending on eller to recei"e the

money from the sale of the cotton to pay off a debt the eller owed to the ban$, paid on the

letter of credit anyway. (ctually, it too$ the credit as payment in full on the debt eller owedit.) The confirming ban$ then forwarded the credit to the issuing ban$ as$ing for

reimbursement. The issuing ban$, which had been tipped off about what had happened by an

employee of the carrier, refused to pay. The confirming ban$ then sued the issuing ban$,

demanding reimbursement. 8hat should the courts decision beF &xplain.