What are the advantages of a bill of exchange over other methods of payment?

The definition of a bill of exchange is set out in Section 3 of the Bills of Exchange Act 1882:

A bill of exchange is an unconditional order in writing, addressed by one person to another…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.

In effect the bill works in the following way; Person A, the drawer of the bill, draws a bill on B, the drawee, ordering him to pay money at some point to C, the holder of the bill (C can also be referred to as the payee or the indorsee). There are two kinds of bill: a bearer bill and an order bill. The former instructs the drawee to pay the person in possession of the bill. The latter instructs him to pay the person whose name it is indorsed to. A bill can also be payable on demand or by acceptance. An example of the former of these is a cheque. This instrument is in many ways different to other forms of bill of exchange, which in some cases causes authors to put them into a separate category. S, however, the truth of these instruments is that they are a species of a bill of exchange and consequently I shall not treat them separately for the purpose of this essay. Bills of exchange are fully negotiable instruments, which means that the holder of the bill can discount the bill to other holders, with an order bill this is done by indorsement. With a bearer bill it is done with transfer.

It is obvious that bills of exchange are not the only methods of payment for goods sold under a contract. Other methods consist of cash payment and credit agreements, which form part of the promise to pay in the contract for sale, and documentary credits. In order to see how bills of exchange rank in relation to these in terms of usefulness and comparative advantage it will be pertinent to first explain the workings of these other methods of payment to establish their own merits.

The first I shall consider is payment in cash. In actual fact cash is technically a form of bearer bill. If one is to look closely at any bank note one will notice the words ‘I promise to pay the bearer on demand the sum of…’ and signed by the chief cashier of the Bank of England. It should, however, for the purposes of this essay, be treated as something different, mainly because it is a unilateral contract made by the Bank to the whole world and does not show us how certain parties to a contract deal with their obligations of payment.

The next method of payment to look at is the credit agreement. Although credit agreements and bills of exchange may on the face of it look the same there are inherent differences, as will be seen later. Credit agreements come in many forms, such as a Hire Purchase, or a Conditional Sale. With many of these agreements the seller will take out what is termed a retention of title clause, keeping property in the goods until they have been paid for and thus gaining security on the credit.

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The final method of payment I would like to consider is the documentary letter of credit. These are usually used to finance international trade when a seller does not wish to be liable to the bank for any default of the buyer in relation to the contract of sale or any ancillary contract. Not only does the documentary credit system prevent this from happening but also it allows the seller to have a guarantee of payment by an entity recognised for its creditworthiness. The buyer of goods is required to enter into an arrangement with an issuing bank. The bank then gives an undertaking to the seller to pay him the price due under the contract provided certain conditions are fulfilled. In one respect a documentary credit bears a striking resemblance to a bill of exchange in that, as will be seen later, the contact of the credit is autonomous to the contract for sale. Indeed it has been stated that ‘a letter of credit is like a bill of exchange given for the price of goods. It ranks as cash and must be honoured. No set off or counterclaim is allowed to detract from it.’

Now to the advantages inherent in the use of bills of exchange. There are three general principles underpinning these instruments; that of autonomy, certainty and negotiability. I should now like to deal with these in order.

Autonomy

The principle of autonomy is, I feel, best put by Lord Russell in Nova (Jersey) Knit v Kammgarn Spinnerei GnbH:

‘The bill itself is a contract separate from the contract of sale. Its purpose is not merely to serve as a negotiable instrument, it is also to avoid postponement of the purchaser’s liability to the vendor himself…grounded upon some allegation of failure in some respect by the vendor under the underlying contract’

The result is that if there is a breach of the primary contract for the goods by the seller, the seller (or other holder) is still entitled to payment on the bill. If the drawee refuses to pay the amount specified then the holder of the bill has an action against him for dishonourment. Conversely, if the drawee defaults on the payment of the bill the buyer of the goods is still entitled to keep them.

In this respect it can be seen why a bill of exchange is better than other methods of payment, which are a part of the contract of sale.

Take credit for example. If a creditee stops payments on a conditional sale or a hire purchase then he will not be entitled to the goods. The seller may refuse to pass title and take the goods back in satisfaction of the debt. This is because payment of the goods is an inherent part of the contract. The credit agreement is not extraneous to the contract.

The same may be said for a cash payment. Although for property to pass under the SGA payment does not have to be immediate, if payment is not made then the seller may be able to retain the goods using his unpaid seller’s right of lien. On the other side of the coin. If the buyer refuses to accept delivery of the goods by stating that they are in an undeliverable state, or that they are not of the correct description of goods as specified by the contract the buyer is still obliged to pay the seller. Although in some circumstances this principle may seem harsh there are many reasons as to why it is better than the provisions for other methods of payment.

One such reason is that, as a negotiable instrument, the bill can be passed to third parties that are no party to the original contract of sale. They should therefore be able to take free from any defects or defaults under the original contract. If they could not then the security and marketability of the bill of exchange would be undermined.

A second reason is that s3 BoEA states that bills of exchange are ‘unconditional orders in writing’. Their payment could not therefore be contingent on the goods being correct or deliverable or subject to the buyer accepting the goods.

Thirdly, it has been stated by many authors and in the judgements of cases that bills of exchange ‘are taken as equivalent to deferred installments of cash’. If this were not the case then it is impossible to see how a bill of exchange could be in any way different from a credit agreement.

Another consequence of the autonomy principle is the relaxation of the contract rules with respect to bills of exchange, especially in the area of consideration. Details of the consideration allowed is set out in s27(1) of which part b is of special importance. This states that consideration can be an antecedent debt or liability. This can be argues to have created an exception to the well-known rule in contract law that past consideration is no consideration. Also the consideration need only be unilateral and need not move from the promisee. More importantly to our discussion is the ability to evade the privity rules. The drawee of the bill is liable to pay whoever holds the bill, even if they were not written into or even intended to be written into the contract. If the contract had been entered into for cash the buyer could not pay anyone but the seller, unless some alterations were made to the existing contract. This would make it much harder for third parties to benefit from cash sales as opposed to sales by bill of exchange.

Certainty

This is another situation in which the unconditional nature of the bill of exchange is of importance. ‘If a bill is to perform its mercantile function, the amount and time of payment must be clear and unqualified, the instrument must speak for itself as a complete and integrated writing’ (emphasis added). The result of this is that whoever holds the bill (unless he is a thief or a forger) knows that it is enforceable and if it is not honoured he has an action on it. This is one way in which a bill of exchange may be better to use than a documentary credit. When the bank contracts with the buyer to open a credit account for the seller it may make the credit agreement revocable. If this is the case then there is no guarantee that the bank will honour the transaction. The seller will be left uncertain whether he will in fact be paid. The same lack of certainty for the seller can be found in credit agreements, which is why the seller often retains property in the goods until payment has been made. With a bill of exchange there is a order to pay, not a request or conditional obligation. There can be no lawful refusal to pay by the drawee unless there in total failure of consideration or the holder requesting payment is a thief.

Negotiability

There are two important benefits that occur from the fact that the bill of exchange is a negotiable instrument. The first of these is the ease of transfer. So long as all the requirements of transfer (such as indoresement where necessary) are met the legal title to the sum payable is transferred. Also no notice is needed to be given to the drawee as he knows that he only pays the person who holds the bill when it is presented to him. This means that there is no need to assign the bill with each transfer. This represents a massive advantage over other methods of payment that do involve assignment, such as credit agreements. The legal assignment has many formalities that must be observed. The assignment must be in writing and signed by both parties. Notice must be given to the debtor otherwise the assignment will only be equitable. Even when the assignment is created legally the assignee may still lose his right to the debt under the rule in Dearle v Hall. An equitable assignment still needs to be perfected by giving notice to the debtor to make it at all secure. It can be seen, therefore, that the indorsee of a bill of exchange is in a much better and potentially much more secure position than your poor old assignee. If he wants to indorse it to someone else all he need do is sign it and, if necessary, write the indorsee’s name on it. If he wants to keep it he is (generally) protected from dishonourment by the drawee.

Another advantage of negotiability is that, in the hands of the holder in due course it is enforceable despite a defect in the title of any prior holder. This has two effects. Firstly, it again gives the holder of a bill of exchange an advantage over a legal assignee as he cannot use the defence of bona fide purchaser for value without notice in order to perfect his title. Secondly it serves as a striking departure from the nemo dat principle. The holder in due course can purchase the bill from a thief and, so long as he is unaware of the defect, obtain a perfect title to the debt. Negotiability is one characteristic that sets a bill of exchange apart from a documentary credit. Although in many respects these two instruments are the same but a big disadvantage of a documentary credit over a bill of exchange is that it is non negotiable thus limiting its usefulness in certain situations.

It can be seen then that there are many benefits to using bills of exchange as opposed to other methods of payment. This is mainly because conceptually it is a completely different monster compared to all the others. That is not to say, however that it will always be beneficial to use a bill of exchange over any other alternative. In some circumstances it is better to use documentary credits, for example when you are conducting in international trade and would have to discount the bill with a bank to finance the shipment. If the buyer refuses to pay for the goods then the seller, as drawer, would be liable to the bank. The bill of exchange in this situation offers little security and the benefits of the documentary credit are greater. The bill of exchange is very important in the world of commerce and it is no wonder that mercantile custom would come up with such a valuable and advantageous concept.

Note here that there are two kinds of indorsement. The drawee will only be able to pay the indorsee if there has been a special indorsement, i.e. the indorsor has written the name of the indorsee on the bill. If the indorsement is made in blank the bill is converted into a bearer bill and the drawee will pay whoever is in possession of it at the time of maturity.

[1977] 1 WLR 713. It must be remembered that this characteristic is also shared by documentary credits.

Sale of Goods Act 1979 s18 rule 1

section 39 and 41 SGA

Nova (Jersey) Knit v Kammgarn Spinnerei GnbH [1977] 1 WLR 713 per Lord Wilberforce.

Note that Goode does not follow this argument and believes that no such exception is created. He believes that it is merely reinforcing ‘the well and established common law rule that a payment or transfer of an existing debt is made for value, for the creditor’s right to payment is thereby extinguished.

Ss54-56 Bills of exchange Act 1882

Professor Goode: Commercial Law p526.

See s136 Law of Property Act 1925

this is in effect a bona fide purchaser of the bill for value without notice of any defects.