A bill of exchange is a written agreement between two parties – the buyer and the seller – used primarily in international trade. It is documentation that a purchasing party has agreed to pay a selling party a set sum at a predetermined time for delivered goods. The buyer or seller typically employs a bank to issue the bill of exchange due to the risks involved with international transactions. For this reason, bills of exchange are sometimes also referred to as bank drafts.
Bills of exchange can be transferred by endorsement, much like a check. They can also require the buyer to pay a third party – a bank – in the event that the buyer fails to make good on his agreement with the seller. With such a stipulation, the buyer’s bank will pay the seller’s bank, thereby completing the bill of exchange, then pursue its customer for repayment.
Promissory notes are similar to bills of exchange in that they, too, are a financial instrument that is a written promise by one party to pay another party. They are debt notes that provide financing for either a company or an individual from a source other than a traditional lender, most commonly one of the parties in a sales transaction. In the United States, promissory notes have historically been limited in usage to corporations or high-net-worth individuals, but have recently become more commonly used, primarily in real estate transactions.
Promissory notes are retained by the payee or seller and, once payment has been completed, must be canceled and returned to the issuer or buyer. In terms of legal enforceability, a promissory note is more formal than an IOU, but less so than a standard bank loan.