A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time.

According to the Section 13 of the Negotiable Instruments Act, 1881 in India, a negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer. So, there are just three types of negotiable instruments such aspromissory note, bill of exchange and cheque. Cheque also includes Demand Draft [Section 85A] is a document contemplated by a contract, which (1) warrants the payment of money, the promise of or order for conveyance of which is unconditional; (2) specifies or describes the payee, who is designated on and memorialized by the instrument; and (3) is capable of change through transfer by valid negotiation of the instrument

Bill of exchange
A bill of exchange or "draft" is a written order by the drawer to the drawee to pay money to the payee. A common type of bill of exchange is the cheque (check in American English), defined as a bill of exchange drawn on a banker and payable on demand. Bills of exchange are used primarily in international trade, and are written orders by one person to his bank to pay the bearer a specific sum on a specific date. Prior to the advent of paper currency, bills of exchange were a common means of exchange. They are not used as often today.

Bill of exchange, 1933

A bill of exchange is 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 fixed or determinable future time a sum certain in money to order or to bearer. (Sec.126) It is essentially an order made by one person to another to pay money to a third person. A bill of exchange requires in its inception three partiesthe drawer, the drawee, and the payee. The person who draws the bill is called the drawer. He gives the order to pay money to the third party. The party upon whom the bill is drawn is called the drawee. He is the person to whom the bill is addressed and who is ordered to pay. He becomes an acceptor when he indicates his willingness to pay the bill. (Sec.62) The party in whose favor the bill is drawn or is payable is called the payee. The parties need not all be distinct persons. Thus, the drawer may draw on himself payable to his own order. (see Sec. 8) A bill of exchange may be endorsed by the payee in favour of a third party, who may in turn endorse it to a fourth, and so on indefinitely. The "holder in due course" may claim the amount of the bill against the drawee and all previous endorsers, regardless of any counterclaims that may have disabled the previous payee or endorser from doing so. This is what is meant by saying that a bill is negotiable.

In some cases a bill is marked "not negotiable" see crossing of cheques. In that case it can still be transferred to a third party, but the third party can have no better right than the transferor

Definition and Explanation of Bill of Exchange:

"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 the bearer". You should keep in mind the following points to understand the definition: 1. The person who writes out the order to pay is called the drawer. 2. The person upon whom the bill of exchange is drawn (who is ordered to pay) is called the drawee. 3. The drawee may "accept" the bill. This is a special use of the word accept because it means that he accepts to pay the amount payable expressed in the bill, i.e. if he accepts the obligation to pay he writes "accepted" across the face of the bill and signs it. From that time on he is know as the "acceptor" of the bill and has absolute liability to honor the bill on the due date. 4. The amount of money must be mentioned clearly. For example, I cannot make out a bill requiring someone to pay the value of my car or house. That is an uncertain sum. It must say "five thousand dollars or ten thousand dollars" etc. 5. The time must be fixed or at least be determinable. For example, "sixty days after date" is quite easily determinable. If the bill is made out on first July, it will be 29th august. 6. The person who is entitled to receive the money from the acceptor is called the "payee". It is usually the drawer who is supplying goods to the value of the bill, and wants to be paid for them. If the drawer decides, the bill can be made payable to someone else by endorsing it. That is why the definition says, to pay..... to, or the the order of, a specified person. 7. A bill can be made payable to a bearer, but it is risky, since any finder of the bill or any thief, can claim the money from the acceptor.

Format of Bill of Exchange:

Now read the definition again and see the format of the bill of exchange below:

Important Points:
1. This bill is drawn by the peter & Co., so the drawer of the bill is peter & Co. 2. The bill is drawn upon William & Co., so they are drawee of the bill. They have not yet accepted the bill, and so are not liable to pay it at maturity.

3. The bill is an unconditional order in writing. It says "pay ten thousand dollars to Peter & Co." it does not say "provided you are in funds". It just says "pay!". 4. It is addressed by one person (Peter & Co.) to another (William & Co.) and is signed by the person giving it (Peter & Co.). 5. The date is easily determinable it is 90 days after first July, which is 29 September, 20.... 6. The sum of money is very certain, ten thousand US dollars. 7. The bill is payable to, or to the order of, Peter & Co.

How a Bill of Exchange Works?

1. A person who wants to purchase goods but has no money, may agree to accept a bill of exchange drawn upon him at some future date for the value of the goods he wants to purchase. For example, Mr. B (a retail trader) wishes to purchase furniture from a furniture manufacturer (Mr. A) but has no money. Mr. A is agreed to sell furniture for a 90 days credit worth $10,000. 2. The drawer (Mr. A) draws a bill for $10,000 on the customer (Mr. B), the drawee, who accepts it (thus becoming the acceptor of the bill) and returns it to the drawer. The drawer delivers the furniture and has a 90 days bill for $10,000. 3. He can keep the bill till due date and present it on the due date before the acceptor. 4. When a drawee (the acceptor) acknowledges the obligation in the bill he is bound by law to honor the bill on the due date. If he is a reputable person the bill is as good as money, and any bank will discount it. There are special kinds of banks which do this job and they are called discount houses. What do the discount houses do? They cash the bill by giving the drawer the present value of the bill. Present Value = Face value of the bill - Interest at agreed rate for the time the bank has to wait So the drawer who discounts the bill with the bank gets less than the face value.

5. On the due date the bank will present the bill to the acceptor, who honors it by paying the full value. The bank has earned the amount of interest it deducted when it discounted the bill. Where does the acceptor get the money to honor the bill? The answer is that he was given 90 days to sell the goods at profit, and therefore, he is liable to honor the bill. Now it is hoped that you will be able to follow what is happening in the following diagrams:

You can understand the figure above with the help of the following notes: 1. Business activities cannot proceed because the retail trader (Mr. B) has nothing to sell and has no money to buy goods.

2. We need a system by which retailer can purchase goods without paying for them at the moment and which enables the manufacturer (Mr. A) to be paid immediately. 3. Since a bill of exchange from a reputable trader is almost as good as money, it will be acceptable to banks. They have plenty of money to lend out to reliable customers so, they will advance money to the holder of bills of exchange. Now look at the following figure and note how bill of exchange can increase the business activities.

The result is that a bill of exchange is a useful instrument to increase business activities, and is beneficial to all the parties.