Articles on Trade Credit

Understanding a ‘Bill of Exchange’ or ‘Draft’ in a Letter of Credit Transaction

The following example illustrates the basics of a ‘Bill of Exchange’ (B/E):

• Let us assume that Seller (X) sells goods to a Buyer (Y) on credit terms of 90 days.
• This sale makes Seller (X) a ‘Creditor’ and Buyer (Y) the ‘Debtor’ who has to pay the Seller (X) back in 90 days.
• However, (X) now requires legal proof from (Y) of this credit sales transaction in writing indicating that monies will be owed for goods sold on credit and it will be paid in 90 days.
• To accomplish this (X) writes a ‘Bill of Exchange’.
• Condition: The Bill written by (X) will have to be accepted by (Y).
• (X) The Creditor writes the B/E and (Y) on whom the Bill is written accepts the Bill by signing and dating it. (i.e accepts that the money will be paid to (X) within the credit terms of 90 days.)
• Since (X) writes the B/E, (X) is the ‘Drawer’ of the Bill.
• Since the B/E is written on (Y), (Y) becomes the ‘Drawee’
• Since (X) receives payment  eventually,(X) is also the ‘Payee’.
• B/E thus is an unconditional ‘Order’ by the Drawer (X). The Order is to pay the Drawer (X) money for value received by (Y).
• Bill of Exchange is a Negotiable Instrument and thus can be transferred from one person to another by endorsement.
• (X) can transfer the B/E to a third party (Z) by endorsement.  In essence the endorsement by (X) to (Z) transfers rights of this B/E from (X) to (Z). (Z) now becomes the ‘Payee’.  (X) was the payee before endorsement.
• (Z) then gains the rights to collect the money from (Y).
• Please note: The terms ‘Bill of Exchange’ and ‘Draft’ are essentially synonyms. However, Bill of Exchange is generally used in International Law, whereas the term Draft is used in the Uniform Customs and Practice (UCP) rules governing Letters of Credit.
• Bottom Line: A Bill of Exchange or Draft is simply an unconditional order written by the seller/creditor/exporter instructing/ordering the buyer/debtor/importer to pay a specified amount of money at a specified time.

Bill of Exchange using a Letter of Credit as an example

• Seller (X) is in Toronto, Canada
• Buyer (Y) is in Frankfurt, Germany
• Seller (X) sells USD 100,000.00 worth of goods to Buyer (Y)
• Buyer (Y) uses the ‘Issuing Bank of Germany’ to get the Letter of Credit issued
• This unconfirmed letter of credit requires a ‘90 days after sight’ Draft from the beneficiary drawn on the issuing bank.

The following is a Sample Draft that will be drawn by the Beneficiary (the Seller) in this example (The Seller (Drawer) will submit this Draft/Bill of Exchange to the Issuing Bank of Germany (Drawee)):

Author: Puru Grover, M.B.A., LL.M.  © Credit Guru Inc | CreditGuru.com