Bills of Exchange (Drafts)

The bill of exchange, commonly referred to as the draft or the bill, is an unconditional order in
writing, signed and addressed by the drawer (the exporter usually) to the drawee (the confirming bank
or the issuing bank usually), requiring the drawee to pay the drawer a certain sum of money at sight or
at a fixed or determinable future time.

The draft is widely used in international trade, most frequently in the payment against a letter of credit
(L/C). It is also used in the open account without any L/C involved.

Drafts Drawn On the Bank

Sample Instrument:  Draft

The "No." (number) in the above sample draft may be used for the exporter's reference number. Blank
drafts are available at the paying bank.

First of Exchange (Second Unpaid)

In practice, it is not uncommon that two drafts are drawn on the drawee bank in a letter of credit (L/C)
to ensure that at least one draft reaches the drawee when they are dispatched separately. The issuance
of more than one draft in a letter of credit follows the same logic as in the issuance of bill of lading in
more than one original. At times even three drafts may be drawn on the drawee bank, this practice was
not uncommon before in certain countries.

In contrast, normally one draft (sola bill) is issued in a documentary collection where the draft is drawn
on the importer.

The sample draft shown above is the first draft, marked "First of Exchange (Second Unpaid)" and the
number "1". In the second draft, if any is issued, is marked "Second of Exchange (First Unpaid)" and
the number "2". Some drafts may not be numbered "1" or "2".
The Letters of Undertaking Instead of the Drafts
In certain exporting countries, the government levy a heavy tax on drafts. In such a circumstance, the
exporter may request the importer to specify in his/her letter of credit (L/C) application that "No drafts
be issued". When the documents are presented to the negotiating bank, the bank issues a letter of
undertaking indicating when and where the money will be paid, instead of accepting a draft drawn by
the exporter.

'Avalised' Term Drafts

The word "aval" in French means endorsement. A term draft accepted by the importer does not
guarantee payment on maturity, hence it is not readily accepted for discounting or as collateral in a
loan. The exporter may arrange to have the accepted draft to be 'avalised' by the importer's bank---the
bank adds its endorsement as guarantee of payment. The 'avalised' term draft can be readily
discounted, thus providing the exporter with immediate funds.

Sight Drafts versus Term Drafts

Sight Draft

The sight draft is most commonly used in international trade. In a sight draft, the payment is on
demand or on presentation of the negotiation documents to the paying bank or the importer. In
practice, the bank may pay within three (3) working days (not instantly) after the receipt and review of
the negotiation documents and if they are in order, that is, the documents comply exactly to the letter
of credit (L/C) stipulations.

In certain countries where the business relationships between the exporter and the bank is well
established, the bank may pay the exporter a few hours after the receipt of the negotiation documents
that are in order.

In the sample L/C it was stipulated "available by your draft(s) drawn at sight", as such the payment is
by sight draft(s).

Term Draft

The term draft---time draft or usance draft---is used in a deferred payment arrangement. The
payment is on the maturity date determinable in accordance with the stipulations of the letter of credit
(L/C). The maturity date can be at a stated period after sight or after date:

 after sight
after the draft is presented to the drawee for acceptance, for example, "at 90 days sight" and
"at 120 days after sight".
 after date
after a specific date, for example, "at 150 days B/L date" (i.e., the maturity date is 150 days
after the date of the bill of lading) and "at 180 days after date" (i.e., the maturity date is 180
 days after the date of the draft).

     Unless the maturity date is tied to a specific date, the importer may refuse to accept the draft
until the goods have arrived, such deferred acceptance can extend the maturity date.

In other words, in a term draft the exporter extends the credit to the importer.

If a term draft is accepted by the accepting bank (in the case of draft drawn on the confirming bank or
the issuing bank or other bank stipulated in the letter of credit), such draft becomes what is known as
banker's acceptance. The exporter may hold the banker's acceptance pending payment by the bank on
the maturity date or discounts it with the bank, thus provides the exporter with immediate funds.

If a term draft is accepted by the importer (in the case of draft drawn on the importer) when it is
presented to him/her by the collecting (presenting) bank, such draft becomes what is known as trade
acceptance. In practice, the collecting bank usually holds the trade acceptance pending payment by the
importer on the maturity date and advises the remitting bank of the date of acceptance. The drawee
may default on the payment of a trade acceptance. Nevertheless, the trade acceptance has a better
chance of being paid by the importer compared to a sales invoice.

The usual way the drawee accepts a draft is by writing or stamping the word "ACCEPTED" on the
face of the draft, plus the drawee's authorized signature and the date accepted.

Unless the importer's integrity is irrefutable, using a term draft is risky, especially when the draft is
drawn on the importer where the remitting bank and the collecting bank are merely acting as agents
without guarantee of payment.

In certain countries, the importer may have access to the customs warehouse or docks and examine the
goods before accepting them. The risk is that the importer may intentionally reject the goods even
when they are in good order and condition, without paying or accepting the draft. The importer may
reject the goods, for example, if the local market prices of the goods have dropped. Unless the goods
are shipped back or rerouted to other buyers, the goods may incur warehousing charges and be subject
to foreclosure after a period of time and auctioned off by the customs. The importer, not surprisingly,
could be one of the bidders at the auction and obtain the abandoned goods at a fraction of the import
cost. A remedy to counter such rejection is to send the draft and documents immediately to the
remitting bank, so that the remitting bank may relay them to the collecting bank and the collecting
bank presents them to the importer for payment or acceptance before the goods arrive at the
destination.

The importer, however, has the right to reject goods that deviate from the contracted specifications and
quality. The importer can instruct the collecting bank not to pay the draft.
Clean Drafts versus Documentary Drafts in the Documentary Collections

In a clean draft, no shipping documents are attached to the draft sent to the remitting bank. The
documents are sent together with the goods, directly to the buyer. Therefore, unless the credibility of
the buyer is unquestionable, using a clean draft in the shipment of goods is risky. The clean draft is
more often drawn for the collection of payment for the services, not goods.

In a documentary draft, the shipping documents are attached to the draft sent to the remitting bank.
The buyer will be able to receive the shipping documents from the collecting bank only after he/she
has accepted the draft for payment later or after he/she has paid the draft.

The Parties in the Collection of Drafts

Drawer
The drawer is the party who issues the draft and to whom the payment is made. The drawer is the
seller (the exporter) and the payee of the draft. The payee could be another party rather than the
exporter, or could be the bona fide holder (the bearer) of the draft.

Drawee

The drawee is the party who owes the money or agrees to make the payment and to whom the draft is
addressed (made out). The drawee is the buyer (the importer), the acceptor and the payer of the draft in
a documentary collection. In a letter of credit the drawee most often is the confirming bank or the
issuing bank, which is the acceptor and the payer of the draft.

Remitting Bank

The exporter's bank to whom the exporter sends the draft, shipping documents and documentary
collection instructions, and who subsequently relays them to the collecting bank in a documentary
collection is called the remitting bank.

The term remitting bank as used under a letter of credit may refer to a nominated bank from whom
the issuing bank or the confirming bank, if any, receives the shipping documents.

Collecting Bank (Presenting Bank)

The bank in the importer's country (the importer's bank usually) involved in processing the
collection---presents the draft to the importer for payment or acceptance, and thereafter releases the
shipping documents to the importer in accordance with the instructions of the exporter---is called the
collecting bank or the presenting bank.