Bills of exchange, promissory notes, and invoices are all financial documents that are commonly used in business transactions. While they share some similarities, there are important differences between them. The key difference between these three documents is that bills of exchange and promissory notes are regarded as ‘negotiable instruments’ as they can be used like cash as they are guarantees of payment. Invoices, on the other hand, are requests for payment based on the delivery of goods or services.
The history of bills of exchange and promissory notes stretch back to the Roman Empire and the first century BCE. The Tang Dynasty in China (8th Century) also developed fey tsien, a prototype of a bill of exchange to safely carry cash over long distances without fear of robbery.
In the UK the Bills of Exchange Act was passed into law in 1882. Many of the commonwealth countries followed suit with similar legislation a few years later.
In the United States the relevant piece of legislation regarding negotiable instruments is the Uniform Commercial Code 1952 (UCC) that sought to standardise commercial transactions over all 50 states.
Most countries in the world have legislated to recognise negotiable instruments. And they are used widely, especially in international trade, as they provide more certainty of payment than just an invoice.
Bill of Exchange
A bill of exchange is a written order that one party (the drawer) gives to another party (the drawee) to pay a specific amount of money to a third party (the payee) at a future date. The bill of exchange is a negotiable instrument, which means it can be transferred to another party, who then becomes the payee. Bills of exchange are often used in international trade, where they can be used to facilitate payments between parties in different countries.
Promissory Notes
Promissory notes, on the other hand, are a written promise to pay a specific amount of money to another party at a future date. Unlike bills of exchange, promissory notes are often not negotiable instruments and cannot be transferred to another party. They are commonly used in personal loans, where the borrower promises to repay the loan on a specific date.
Negotiable and Non-Negotiable Promissory Notes
When a designated payer of a promissory note is presented with the note by the person who lent money it is possible for the issuer of the promissory note to transfer or assign the note to another party. In this instance, a promissory note is regarded as ‘negotiable’.
In modern finance it is often the case that the issuer of a promissory note doesn’t want to involve a third party. This is because the third party to whom the payee transfers the promissory note obtains the right to payment from the payer as specified in the note but isn’t bound by the terms of the agreement that sets out the conditions governing when the payee can demand payment. In this instance it must be stipulated that the promissory note is ‘non-negotiable’.
Invoices
Invoices are simply a bill for goods or services that have been provided. Unlike bills of exchange and promissory notes, invoices do not represent a promise to pay at a future date. Instead, they are a request for payment for goods or services that have already been provided. In legal terms, payment of an invoice can be withheld for a number of reasons such as a query on a delivery of goods or services. Invoices are usually issued under the legal protection of a signed contract specifying payment terms.
Difference Between Bills of Exchange and Promissory Notes
One of the key differences between bills of exchange and promissory notes is that bills of exchange are typically used in commercial transactions, while promissory notes are more commonly used in personal loans. Bills of exchange are issued by the creditor while promissory notes are issued by the debtor. Both are negotiable instruments (unless the promissory note is designated ‘non-negotiable’), which means they can be transferred to another party. Bills of exchange are more flexible than promissory notes, which are tied to a specific individual or company.
Another key difference between bills of exchange and promissory notes is that bills of exchange require three parties – the drawer, the drawee, and the payee – while promissory notes only require two parties – the borrower and the lender. This makes bills of exchange more complex than promissory notes and requires additional documentation and legal requirements.
Digitalising Negotiable Instruments
Whereas most countries recognise the legality of a digital invoice, the same cannot be said for bills of exchange and promissory notes. The EU have established standards for e-invoicing that give them the same legal status as paper invoices.
In contrast the original paper bill of exchange or promissory note must be presented to the payer to enforce payment. There is a danger the paper bill or note will get damaged or destroyed and the payment of the debt is no longer legally enforceable. Moreover, the presentation of a bill of exchange or promissory note is delayed by the need to transport the documents.
For these reasons, there is a growing demand to enact legislation to allow for bills of exchange and promissory notes to be drafted, issued and presented digitally. The ITFA Digital Negotiable Instruments (DNI) Initiative is a project that aims to promote the digitization of negotiable instruments in trade finance. The International Trade and Forfaiting Association (ITFA) launched the initiative in 2019 in partnership with technology firms, banks, and industry associations. The key drivers behind this initiative propose the use of decentralised ledger technology (as used in blockchains) to guarantee the authenticity of the negotiable instruments on a ledger that cannot be tampered with and that can be accessed by all relevant parties.
In Summary
Bills of exchange, promissory notes, and invoices are all important financial documents that are used in different types of transactions. While they share some similarities, such as representing a promise to pay a specific amount of money, they are different in terms of their negotiability, the number of parties involved, and the type of transactions in which they are used. Understanding these differences is important for anyone involved in business transactions.
