Paper Bills of Exchange inhibit Finance

Uniform Commercial Code hasn’t moved to the 21st century with Bills of Exchange

It’s 2014 and we have cloud solutions, online purchases, PayPal, pcards, chip and pin, online deposit capture, but Bills of Exchange still must be paper.

For those of you who don’t know what a Bill of Exchange is and how important it is in commerce, the Bill of Exchange /draft has the following characteristics

  • It is a contractual payment order both amount and date certain
  • It is issued by the seller (as opposed to a cheque) and accepted by the buyer (via signature), in other words, signed by both parties.
  • It is also negotiable. Article 3 in the Uniform Commercial Code states “Negotiation is a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder."
  • When a bill of exchange as a payment order bounces for lack of funds, there is an event of default.

Basically, it is a contract between two parties about a future date certain amount and event.

Just think about the above for a minute and compare that to a cheque. A cheque is issued and signed by the buyer, but there is no assurance that funds are in the account. In contrast, the Bill of Exchange is prepared by the seller and drawn on the issuing bank and/or the buyer. It has an equivalent effect of a cheque written from the buyer to the seller.

Letters of Credit (L/C) use a bill of exchange drawn on the buyers bank, which accepts the Bill of Exchange when all of the conditions of the “Letter” have been satisfied, i.e. all discrepancies resolved. The problem with the L/C is that it DOES NOT extend credit to the buyer nor does it finance the seller’s receivables. A letter of credit is a payment instruction. See – You want a Letter of Credit, Really?

The emphasis is on the word letter not on the word credit. The BUYER effectively prepays for the goods, as the buyer must provide collateral either in the form of cash/hard assets, or if the buyer has a line of credit from the bank which issues the L/C, that line of credit is often supported by hard assets.

The bill of exchange could be a powerful tool to further enable finance. From the perspective of the financier/guarantor, a bill of exchange represents certainty of information, and a very low cost for information about all successful transactions. Once accepted by the buyer, the bill of exchange is in control of the seller, or the financier/guarantor, not the buyer. The only cause for denial of payment of a bill of exchange is “fraud.”

The Uniform Commercial Code (UCC) governs the Bills of Exchange in the USA– see Article 3

According to Anastasi Tsakatoura of, to recognize bills of exchange in electronic form one of two things must happen.

  1. Modify the UNCITRAL Model Law on Electronic Commerce 1996, as amended in 1998 to accept electronic bills of exchange
  2. Verify if electronic variations satisfy present laws


He states:

For negotiable instruments in the form of bills of exchange and promissory notes to preserve their expediency in international trade during the third millennium, they must be recognised as valid in electronic form. Then again, are those electronic instruments capable of satisfying the legal requirements set out in the various statutory provisions of different jurisdictions so as to represent valid negotiable instruments? It has been proposed that in order to ensure certainty in the international trade context, a uniform law regulating the issue shall be adopted. Such a uniform law might be for example the existing UNCITRAL Model Law on Electronic Commerce 1996, as amended in 1998, which, if adopted, could overcome deficiencies in the current statutory regimes and increase certainty in relation to the enforceability of electronic bills of exchange.

In the absence, however, of such a uniform law and in order to effectively analyse whether or not it is feasible to substitute the negotiable instruments with electronic variants, it seems to be necessary to examine whether those electronic variants satisfy the requirements of the present law. To do so, we will compare their characteristics with those outlined in the UK Bill of Exchange Act 1882 (BEA 1882), which is the main statutory body providing for paper-based negotiable instruments in England. Although, our analysis will concentrate mainly on bills of exchange, however, due to the similarities in their application, the same provisions will apply to promissory notes correspondingly.

Can you imagine how useful it would be to allow this payment instrument to be electronic and have the law govern these transactions? Given the relatively higher safety associated with two parties signing, and identification of default, it can become an instrument that facilitates trade finance in an electronic form.



First Voice

  1. Tony Brown:

    David, thanks for taking up my suggestion to focus on this subject. In my view, the bill of exchange (aka trade draft) is too important and useful as a negotiable instrument to atrophy along with other paper-based form of trade.

    Here are a few additional points to add to the discussion….

    1. In October 2009, the People Bank of China (the central bank) launched the Electronic Commercial Draft System (ECDS). The consequence has been a rapid growth in the use of trade drafts by financial institutions to finance commercial trade (they now represent 16% of total Chinese money supply according to the PBOC). They recognized that paper drafts faced a number of problems that could be solved via use of IT. These include operational inefficiency, errors in draft execution and discount, dishonor by non-payment and fake drafts, and unregulated innovation. The ECDS introduced a market and rules for trading and settling accepted drafts.

    2. Trade drafts offer key advantages in financing domestic and international trade:
    a. Once a trade draft is accepted by a buyer it represents an unconditional legal obligation to pay that is separate from the underlying sale contract with a supplier.
    b. The unconditionality of the buyer’s payment obligation removes dilution (dispute) risk and thereby encourages lenders to finance a higher percentage of the buyer’s payable
    c. The accepted trade draft doesn’t affect the right of recourse the buyer may have to the supplier for non-performance
    d. A “without recourse” endorsement of the accepted draft by the supplier shifts the credit risk of non-payment by the buyer to the lender (who can either accept this risk, insure it, or sell it to another party)
    e. The use of trade drafts in reverse factoring can facilitate accounting treatment of such financing as trade payable discounting versus incurrence of bank debt on the buyer’s balance sheet
    f. Since the trade draft is a payment instrument (i.e. not the invoice itself) it might be an effective way to circumnavigate restrictive covenants that a secured lender may require of a borrower (supplier) not to assign or pledge receivables to a third party.
    g. As a negotiable instrument, a lender that discounts (or rediscounts) an accepted draft in good faith without notice that it is overdue or has been altered can rediscount it with another lender as a “holder in due course”. This facilitates funding/refinancing of trade receivables/payables.

    3. The fact that trade drafts must be accepted in writing in paper format results in a cumbersome daisy-chain process that substantially detracts from the above benefits. The sooner we get to treat trade drafts like other contracts permitted by State and Federal law to be electronically executed the better.

    Trade drafts used to be signed by a quill pen (that’s how long they’ve been around). It’s now time to substitute an electronic signature!

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