Drafts

A draft is a financial instrument issued in negotiable form. It is a request for an unconditional payment in writing from one party or person to another. It is signed and dated by the maker requiring the party or person to whom it is addressed to pay to the order of a named person [or the bearer] a sum certain in money at a fixed or determinable future date. A draft is similar to a check drawn on a drawee (the bank) by a drawer seeking reimbursement or financing for goods or services. A draft is also known as a bill of exchange. A bill of exchange is described under the Negotiable Instruments laws. Sight and time drafts are rarely used in business to business transactions within the United States.

Sight drafts are requests for immediate payment. Buyers, or their bankers, honor sight drafts by paying them when presented. Time (usance) drafts are requests for payment in the future. Occasionally, time drafts include an interest requirement for collection in addition to the face amount at maturity. For example: "Payable with interest at 8 percent per annum from the date of acceptance when a drawee acknowledges in writing on the face of the draft that the buyer will pay the draft at maturity. until the date of maturity."

Buyers or their bankers honor time drafts by accepting them. The acceptance of a time draft by a buyer is known as a trade acceptance. The acceptance of a time draft by a bank is known as a bankers' acceptance. In either case the draft is no longer called a draft but an acceptance.

In order to execute a proper acceptance, the banker or the buyer (depending on who is the drawee in the draft) must do the following:

• Print, write, or stamp the word "Accepted" across the face of the draft. 
• Place the date of execution alongside, above, or below the word "accepted." 
• "Domicile" the draft by naming on the draft a place of payment at maturity such as "Payable at." 
• Ensure that the name of the drawee also appears along with a signature of a duly authorized representative of the drawee. The title of the signer or the words "Authorized Signature" must appear. 

Draft Characteristics (Eight Points of Negotiability)

(1) A sum of money in figures.

(2) A sum of money in words.

(3) Date of issuance of the instrument.

(4) The date the instrument is due and payable. The time of payment may be "on demand" or "at sight," meaning it is presented for immediate payment. Thus, you "honor" a sight draft by paying it. If the draft is not to be paid immediately, then it is drawn to mature for payment at a fixed or determinable future date. This is known as a time or usance draft. You "honor" a usance draft by accepting it.

(5) An unconditional order in writing to pay to the order of a specified person or to a bearer. The word "order" is a key word of negotiability. The draft thus can be negotiated, which means the instrument may be transferred by the named payee by endorsement, or transferred by delivery if specified to order of bearer.

(6) The specific person to whom payment is to be made is called the "Payee." This person must be shown on the draft.

(7) The person on whom the draft is drawn is called the "Drawee." It is the debtor who is given the order to pay when due. The "drawee" honors a time draft by accepting it and consequently becomes an "Acceptor" and paying at maturity. The drawee honors a sight draft by paying it at time of presentment.

(8) The person requesting payment and presumed owed money and who in writing by drawing or issuing the draft gives the order to the drawee to pay is called the "Drawer."

The word "person" as used in the above definitions applies to partnerships, corporations and trade names as well as to natural persons.

Parties to the Draft

There are three main parties involved in the execution of a draft:

(1) The drawer, which is the seller or exporter who draws the draft.

(2) The drawee, which is the person or company to whom the draft is addressed who can be the buyer, importer or a bank under a letter of credit transaction.

(3) The payee is the specific person or company to whom payment is directed.

The drawee is given a new title if a time draft is involved. If the drawee agrees to the request for a future payment, the drawee then becomes an acceptor.  The payee must endorse the draft when presenting it for payment, thus becoming an endorser.

Why are drafts important?

Drafts are important because as evidence of the debt owed by a buyer to a seller. Drafts are a means of settling accounts in domestic as well as international trade. If the sale is made on open account terms and the buyer does not present a draft to the seller, there is less pressure on the buyer to fulfill its obligation to pay for the merchandise in a timely manner. As a result, a buyer may try to its payment obligation because the pressure to pay is strictly from the seller.

Without a signed draft, there will be no collecting bank to ask the buyer to settle the debt as agreed. In countries where foreign exchange controls exist, an importer purchasing on open account terms may have a hard time obtaining the foreign currency necessary to pay the exporter/seller because of a lack of acceptable proof of import transaction related indebtedness. In many countries, a draft is tangible evidence of money to be paid to a foreign exporter, and can support the drawee's foreign exchange requests.

Drafts are also important as a support for a loan or an advance to the seller. One of the most significant draft characteristics is the negotiability feature of a draft wherein the right to the payment may be transferred from one entity to another, meaning that drafts can be used as finance collateral.

Sight and time drafts support foreign sales whether the sales are made on:

• Open account, 
• Collection, or 
• Letter of credit terms. 

Edited by Michael C. Dennis, author of "Credit and Collection Handbook"