A client called from his cell phone as he drove to the bank with a set of documents to present for payment on a letter of credit, which expired at the end of the day. While speeding on the interstate, he asked about the format of a draft.
As best I could with words, I tried to create an image in his mind of what a draft looks like. I also informed him he could purchase some from an office supply store, or we could give him one from our supply cabinet.
When he asked if he needed a printed draft, I said, “No, we will permit a hand-written form.”
Then he asked, “Can I design a form on any kind of paper?” I assured him those details had nothing to do with the legal purpose of a draft as long as it contained the correct criteria.
Approximately 30 minutes later he rushed into the bank with the documents and his hand-written, hand-designed form. Hastily sketched on a brown paper bag that earlier had carried his lunch, it had all the components and criteria for a proper draft and we found no reason to refuse it.
Presenting a Draft to Your Bank
Many international transactions require a document referred to as a draft. While some people have an idea of what and when to use it, they often have questions about the technicalities and the form. While various financial transactions require a draft, we will limit our discussion here to the use of a draft in typical international transactions.
A draft can simply be defined as a demand for payment. The major components of a draft include the drawer, who demands the payment; the drawee, who makes the payment; the payee, who receives the payment; the tenor, which indicates the date of payment; and the amount of the draft or the amount of the payment demanded.
Sight Draft versus Time Draft
The tenor of the draft determines a sight or a time payment. The drawee honors a sight draft, identified with a tenor “at sight,” by paying it when sighted. A time draft indicates payment a certain number of days after a date or an event for the payment, for example, “30 days after the bill of lading date.” In summary, the drawer demands payment from the drawee and instructs the drawee to make payment to the payee of a certain amount on a certain date.
In a typical documentary collection payment, the exporter is the drawer, the buyer is the drawee, and the exporter is the payee. In a typical letter of credit transaction, the beneficiary is the drawer, the issuing bank is the drawee, and the beneficiary, or beneficiary’s bank is the payee. The payee endorses the draft, making it negotiable.
If the buyer successfully obtains extended payment terms, a time draft becomes the proper term to describe the payment. In this scenario the drawee accepts the draft after the documents arrive at his bank. The drawee signs a notation across the face of the draft, obligating himself to pay on the agreed upon maturity date, often tied to the bill of lading date, such as 30 days after the bill of lading date, or tied to the date of acceptance of the draft, or some other criteria.
When the drawee of a time draft is the buyer, the accepted draft becomes known as a trade acceptance to distinguish it from a bankers’ acceptance, a time draft drawn on and accepted by a bank. The accepted draft, similar to a promissory note, represents money owed by one party to another party. Because a bankers’ acceptance presumably carries less risk, the holder prefers it to a trade acceptance.