Briefing 2 of 4: Bill of Exchange Default
In the second of our series looking at the impact of the global credit crisis and downturn, we look at one of the longest serving finance instruments still current in today’s market, the bill of exchange (often known as a “Draft”) – a term used interchangeably in this article. As well as being one of the oldest payment instruments it is a rarity in being the only one (alongside the Promissory Note) which is the subject of detailed legislation under English Law. A comprehensive code passed in Queen Victoria’s time known as the Bills of Exchange Act 1882 still regulates this instrument and sets out strict rules as to how they should be produced and dealt with.
A bill of exchange (a commercial version of the cheque to the man in the street) is (i) an unconditional order in writing; (ii) addressed by one person (the drawer, typically the exporter); (iii) to another person (the drawee – typically the importer); (iv) signed by the drawer; (v) requiring the drawee to pay on demand (a “sight” draft) or at a future determinable date (a “term” draft); (vi) a certain sum in money; (vii) to or to the order of a specified person (the payee) or to the bearer of the bill. In practice the drawer and the payee are often one and the same person. Its main purpose is to bring into existence an irrevocable payment promise by the person who accepts to pay it – sometimes the importer himself but often his bank.
Drafts were once common place in international trade and are still frequently used as the payment mechanism in documentary collections. A D/P or document against payment transaction involves a “sight” draft while a “term” draft is used in a D/A or document against acceptance transaction.
Why is that different from or better than general open account terms?
The key characteristic of the bill of exchange is that alongside the bill of lading it is one of the only truly “negotiable” or transferable instruments in international trade. A “bearer” bill is simply transferred by physical delivery of the bill to the next holder while an “order” bill is transferred by indorsement by the holder and then delivered.
“Accepted” drafts therefore can be and often are held at maturity by third parties to the original transaction - some of whom will have purchased the draft at a discount to its face value, possibly through a forfaiting transaction.
The third party holder of such a bill of exchange is known as a “holder in due course” and much like the beneficiary of a bank guarantee or a letter of credit he is entitled to be paid by the acceptor (and in some cases by previous indorsers) of the bill, no matter what contractual dispute may exist in the underlying transaction. This characteristic makes the bill of exchange an attractive instrument for on sale in the secondary market to a party willing to take the country and credit risk of the importer or his bank.
What if the drawee/acceptor fails to pay?
We live, however, in fairly strange times in terms of credit behaviour. Traders and bankers have been badly affected by the lack of liquidity in the market and those holding term drafts maturing this year end will be watching and waiting anxiously to see if the credit standing of the paying party has changed substantially since the draft was originally accepted for payment. If worst fears are realised and payment is not forthcoming the Bill of Exchange Act has strict rules that have to be followed in order to enforce the holder’s rights so it pays to know what those rights are and, very importantly, the procedure that needs to be followed in order to protect those rights.
Who is liable on the accepted draft and what defences might be raised?
It is a curiosity of the Bill of Exchange Act (bound up to some extent with the strict Victorian code of business ethics, which was prevalent at the time that it became law) that almost everyone involved in producing, accepting and indorsing a draft, can in principle be liable in the event of its non-payment. The bill of exchange itself can be sued on (rather than the underlying contract) if it is “dishonoured” because it is a separate contract between the person holding it and the person liable to pay it.
A draft is “dishonoured” either when a sight draft (ie. one payable immediately) is unpaid on presentation or when a term draft (ie. one payable at a later maturity date) is either not accepted at all or, more often, is unpaid at the later maturity date after it has been accepted.
Any technical defect in the form, execution or protesting of a bill of exchange can afford the paying party a defence. Also, a holder of a bill who obtains it dishonestly or when it is already overdue for payment will not be able to enforce it.
What damages can I receive?
The damages which the holder in due course of the bill can recover are the face amount of the bill itself, interest from the date of presentment for payment (if it is a sight bill) or from the date of maturity (for any other bill), plus the expenses or “noting” or “protesting” the bill, where this is necessary, for which see below.
Protesting “foreign” bills – the small print
The Bill of Exchange Act recognises two types of bills, an “inland” bill which is a bill which on the face of it is both drawn and payable within the UK and Ireland (quaintly referred to in the 1882 Act as the “British Islands”), and any other bill which is a “foreign” bill - there were no special rules for Europeans in 1882. It follows that a bill can be drawn in London and ultimately payable in London and in between times might be indorsed in several cities in Europe and across Asia and it would still be an “inland bill” for the purpose of the Act, but a bill that is, for example, drawn in London on a London commodity trader but payable in Paris at the counters of a French accepting bank is a “foreign” bill as would be a bill drawn in Hong Kong on a London commodity trader and payable at a London bank. The bill will state on in its face where it was drawn and will show the address of the person who will pay it so one can work out what is and is not a “foreign” bill.
If the bill is a “foreign” bill then, if it is dishonoured by the drawee (importer) or an indorser at sight or maturity, it must be “protested”. The bill has to be given to a notary public, in the place where it is payable, who personally calls on the drawee/indorser and demands payment. If payment does not occur then the notary public draws up a Deed of Protest in which he states the reasons for dishonour (ie. generally non-payment). A foreign bill has to be protested within one working day of dishonour; otherwise under the Bills of Exchange Act 1882, all signatories on the bill are freed from liability. Banks are often used as agents for presentation of bills for payment. A large percentage of bills are in fact accepted.
If the bill has been “accepted” – typically by the importer’s bank – then generally it is unnecessary to protest the bill if the acceptor fails to pay.
Ordinarily, the following parties to a bill or draft are liable:-
(1) the drawer of the bill is liable by drawing it;
(2) the acceptor of a bill is liable by accepting it;
(3) the indorser of a bill is liable by indorsing it;
and each of those parties becomes liable to indemnify any of the others who have been forced to pay that liability in his place.
Avoiding liability as an Indorser
From the commercial point of view, this enduring potential liability as a result of having at one time indorsed a bill in a chain of parties to a transaction is extremely inconvenient and does not allow for much contractual and financial certainty. As a consequence, the ability to insert an express stipulation to negative the liability of a drawer or an indorser of the bill (though not the acceptor of the bill) is generally relied upon. When either the drawer or an indorser signs the bill, he can add the words “without recourse” the effect of which is to deny any liability resulting from his signing of the bill.
“Where do I sue?”
Although in theory it is possible for a party to stipulate expressly on a bill of exchange, proper law and jurisdiction provisions, in practice this is never done.
The Bill of Exchange Act itself sets out a broad set of rules to determine conflict of law issues but as a general rule the place where the particular act or dealing in relation to a bill (be it the acceptance, indorsement or dishonour) takes place, is the place whose law will apply and whose courts will determine the outcome.
The consequence of that is that a bill of exchange accepted in Vietnam, for example, will, upon dishonour usually have to be pursued against the acceptor who has failed to pay in Vietnam, through the Vietnamese courts unless a specific choice of law or jurisdiction clause is included.
First steps to be taken in the event of a non-payment:-
- Check whether the draft needs to be protested and if it does do it immediately. If it has been accepted there is no need to protest.
- If the draft needs to be enforced abroad get advice quickly on any procedures locally that need to be followed.
- If the drawee/acceptor of the draft are unable to pay, check whether any other party including a previous indorser remains liable – have all previous holders indorsed “without recourse”?