Template:M intro repack Bills of Exchange Act 1882

A bill of exchange is a primordial means of extending credit, whose antecedents one would do well to understand, as quite a lot of contemporary business of extending credit depends on them. This stuff is not immediately intuitive, but when you get in to it, it has a logic of its own, and is rather fun. We recommend it.

History: Lord Mansfield and all that

Historian Jane Samson wrote an excellent article in the Dalhousie Law Journal in 1988, from which some of this history is taken. In Heylyn v Adamson [{{{3}}}] {{{4}}} {{{5}}} Lord Mansfield drew a distinction betweem “inland bills of exchange” where the drawee is to pay, and “notes of hand” (now called promissory notes) where the drawer is to pay (that is, drawer and drawee are the same person.

Addressed promissory notes — those not made out to bearer — are bilateral arrangements, until they are negotiated to a third party, at which point they look exactly like bills of exchange — the act of “negotiating” and “drawing” being economically equivalent.

“Bill of exchange”

Defined in section 2 as:

“an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person, or to bearer”

Unpicking this there are three parties involved here: is the person making the order (the “drawer”) who directs its bank or moneybags of some kind (the “drawee”) to pay a specified sum to a third party creditor (the “payee”). Hence the exchange: Drawer gives payee the bill in exchange for goods and services. The drawee accepts it as good value recognising it as a claim for the payment of money — a debt — against the drawee.

One needs to designate clearly who is drawer and drawee: where the parties are different and the bill is payable on demand, older readers may recognise the arrangement as resembling a cheque:

The third party payee — the person to whom the bill is issued as credit for something — need not be named, and if she is not the bill will be payable on presentation by the bearer. If the payee is named, she may only transfer the instrument by indorsing it.

This triangular arrangement makes for uncertainty at the point of delivery, especially as the drawee is not represented. How does the payee know the drawee will acknowledge the debt? This is depends on a preexisting arrangement, to which payee is not party or even witness, whereby drawee agrees to honour bills drawn by drawer, against reimbursement in due course by the drawer. And a fee, and interest. Hence Sir MacKenzie’s good sense to enshrine all this in legislation which, once settled, ought not need to be changed unless technology should intervene to change the way merchants do business.

So there are some complicated arrangements springing into life here:

• A payment obligation between drawer and payee conditionally discharged by delivery of a bill
• A payment obligation between drawee and payer which, if dishonoured, triggers reinstatement of the primary payment obligation from drawer
• A payment obligation from drawer to drawee to reimburse the latter for settling its original payment obligation.

Derivatives fans may see this as redolent of a give-up.

Negotiability

All this is further confused if the holder of a bill of exchange is entitled to negotiate it — to sell it, effectively, in the secondary market to a random third party.

If it is a bearer bill, one can negotiate it by simple delivery. If the bill is made out to specified payee, the payee can “indorse” it, by signing it.

You might think there is some scope for fraud here, and you might be right. There are many provisions on the Bills of Exchange act about that.

“Promissory note”

A bill where the drawer and the drawee are the same person — that says, effectively, “I direct myself to pay you this sum, only later” — is a promissory note. An IOU, effectively. Debt securities generally have this character. They are a form of securitised loan.