Bills of exchange and cheques: which securities can be discounted by your bank?

Bank discounting, as we saw in our general presentation of this mechanismis based on the mobilisation of a receivable before its maturity date. However, to be eligible for this type of credit transaction, the receivable must generally be evidenced by a specific document that the company gives to its bank. The nature of the security is not neutral: it determines not only the feasibility of the discount but also the extent of the rights and guarantees enjoyed by the bank, and by extension, the obligations and risks for the remitting company.

Although, in theory, any certain and liquid debt could be the subject of an advance, the banking practice of discounting concentrates on well-defined instruments offering sufficient guarantees of recovery. So what are these preferred securities that your bank will accept (or refuse) to discount? Mainly bills of exchange and, to a lesser extent, cheques. Understanding the characteristics and issues specific to each type of security is fundamental.

Commercial paper: the preferred instrument for discounting

French law does not provide a single legal definition of a "commercial paper". There is general agreement among legal writers that it is a negotiable instrument that evidences a claim to a sum of money in favour of its rightful bearer and is used to make payment.. These securities are designed to circulate easily (by endorsement) and offer specific guarantees to successive holders thanks to the rules of the law of exchange. The main commercial instruments used for discounting are bills of exchange, promissory notes and warrants.  

Bills of exchange: the historic instrument

The bill of exchange, sometimes called a "draft", is without doubt the most emblematic instrument and the one most frequently associated with discounting. In fact, discounting has historically developed around this instrument.. It is based on a triangular relationship: one person (the drawer, usually the seller/supplier) instructs another person (the drawee, the buyer/customer) to pay a specified sum of money, on a future date (the due date), to a designated beneficiary (who may be the drawer himself or a third party, such as the discounting bank)..  

For companies wishing to discount a bill of exchange, there are a number of points to bear in mind:

• Acceptance: The drawee can "accept" the bill of exchange by signing it. By doing so, he acknowledges that he owes the sum and undertakes personally and directly to pay the bearer on the due date. An accepted bill of exchange offers greater security for the discounting bank. However, acceptance is not a condition for the bill to be valid or discountable. The bank may very well discount a bill of exchange that has not been accepted, but in that case it takes on an additional risk, which is often offset by a specific commission.  
• Milking pro forma : In certain situations, in particular in public contracts or when the drawee refuses on principle to have bills of exchange drawn on him, practice has developed "drafts". pro forma" . These are bills of exchange, often unaccepted and not intended for circulation, given to the bank solely to evidence the debt and allow discounting. Case law accepts their validity. The banker acquires ownership of the underlying debt (the provision), but his guarantee is essentially based on this debt. He must therefore be particularly vigilant as to the reality and due date of the corresponding service (goods delivered, work carried out).  
• The danger of complacency : This is a dangerous and illegal practice. A bill of convenience is a bill of exchange (or other instrument) created and accepted when there is no real debt or commercial transaction between the drawer and the drawee. The sole purpose is to enable the drawer to obtain credit by discounting the bill, often with the intention of repaying this discount by issuing a new bill of convenience (a mechanism known as "cavalry"). These bills, which are based on a lack of cause or an illicit cause, are null and void. However, this nullity is not enforceable against a holder acting in good faith (who was unaware of the fictitious nature of the transaction). A bank that knowingly discounts a bill of convenience (in bad faith) loses its recourse to the courts and may be held liable or even prosecuted as an accessory to fraud. Bad faith on the part of the banker is strictly assessed by the courts: the banker must be aware that he is causing damage to the debtor by depriving him of a legitimate exception. Mere negligence or carelessness is not sufficient to constitute bad faith. For companies, issuing or accepting such instruments involves considerable risk.  
• LCR (lettre de change-relevé) : To reduce processing costs, computerisation led to the creation of the LCR. The "paper LCR" is based on a genuine physical bill of exchange, the information on which is then processed magnetically; it remains perfectly discountable because the security exists and can be endorsed. On the other hand, the "magnetic LCR" is created directly on a computer medium, without issuing a paper document. The majority of legal writers consider that it does not constitute a genuine negotiable instrument in the traditional sense. As a result, it cannot be discounted in the strict sense (no endorsement possible, no transfer of chamber guarantees). Financing transactions based on magnetic LCRs are more a matter for other techniques (collection mandate, Dailly-type assignment of receivables). It is therefore essential to make a clear distinction between these two forms of CRL.  

Promissory notes

The promissory note is another frequently discounted instrument.. Unlike a bill of exchange, this is a direct commitment rather than an order to pay. One person (the subscriber) undertakes to pay a specified sum, on a fixed due date, to another person (the beneficiary) or to his order.. It is based on a bilateral relationship. The rules governing its creation, transmission by endorsement and payment are very similar to those of the bill of exchange, and it therefore offers comparable guarantees for discounting.  

The warrant

A warrant is a more specific type of commercial paper, mainly used in the agricultural sector or for goods stored in general warehouses. It combines a promissory note (promise to pay) and a pledge on the goods concerned.. Discounting a warrant therefore provides the bank with a security interest in the pledged assets, in addition to the usual foreign exchange remedies. Its complexity and narrower scope make it less common than bills of exchange or promissory notes in general corporate discounting transactions.  

Cheque discounting: a validated but specific practice

At first glance, the idea of discounting a cheque may seem surprising. The law defines a cheque as an instrument of payment on sight. Theoretically, it should be paid as soon as it is presented and does not include any future due date allowing early credit.  

However, the banking practice of "discounting cheques" does exist and has been validated by case law.. Why is this? Essentially to meet a need of companies that receive cheques but whose actual cashing may take several days (interbank clearing times). To avoid this cash-flow delay, the bank may agree to credit its customer's account immediately with the amount of the cheque submitted, in return for a fee, even before it has received the funds from the drawer's bank.  

Although sometimes referred to as a "discount", this operation is more akin to an advance on collection or a very short-term credit facility, guaranteed by the delivery of the cheque. The bank takes a risk: that the cheque will be returned unpaid (because of insufficient funds, a stop payment order, etc.). In this case, as with a negotiable instrument, the bank will take action against the customer who issued the cheque, in particular by reversal.  

There are a number of points to bear in mind:

• Post-dated cheque : Postdating cheques is illegal in France. The cheque remains payable on demand, regardless of the date entered. A bank that agrees to "discount" a cheque on the basis of a future date would be committing an irregularity.  
• Postal cheque : Since the change in the status of La Banque Postale, postal cheques have been subject to the same legal regime as bank cheques and can therefore be subject to the same advance collection operations.  

Discounting cheques, although possible, is therefore a very short-term overdraft facility rather than a true discounting operation in the cambial sense of the term.

Securities excluded from traditional discounting

Certain securities, although representing a value or claim, are generally not eligible for traditional bank discounting:

• Securities representing goods : Bills of lading (sea transport), consignment notes (land transport) or warehouse receipts represent a right to goods and not a claim to a sum of money that can be directly discounted. Other inventory financing techniques exist.  
• Capital or investment securities : Stocks, bonds, shares or fund units are not forward payment instruments and their value fluctuates. They cannot be discounted. They may be used as collateral (pledge of securities account) for other forms of credit.  
• The "bordereau de cession de créances professionnelles" ("bordereau Dailly"): Created by the Dailly Act of 1981 (codified in articles L. 313-23 et seq. of the French Monetary and Financial Code), this form allows a company to assign or pledge a set of business receivables to its bank to secure a credit transaction. Although it can be used to pledge receivables, the Dailly agreement is not a legal instrument. not a commercial paper. It is subject to its own legal regime, distinct from discounting. The transfer of receivables and the associated guarantees (in particular the transferor's joint and several guarantee, unless otherwise stipulated) are governed by these specific texts and not by the law governing bills of exchange. Discounting a commercial paper should therefore not be confused with mobilising receivables via a Dailly slip, even though the economic objectives may be similar.  

In conclusion, while commercial paper, and particularly bills of exchange, are the core of discounting operations, the possibility of obtaining an advance on cheques also exists. Each instrument has its own characteristics, advantages and risks. Vigilance is required to ensure that the securities issued are in order (in particular that there is no indulgence) and that the underlying legal mechanisms are properly understood, in particular the liability of the issuer in the event of non-payment. A good knowledge of these different securities and how they are processed by banks is an asset for optimising cash management and securing financial relations. Don't hesitate to consult our practical guide to discounting for an overview.

The nature of the security presented for discounting has important legal implications. If you have any doubts about the eligibility of a security or a dispute concerning a discounted bill, our firm is at your disposal to analyse your situation and advise you on the best course of action. You can contact our team via our Lawyer - Discounting.

Sources

• French Commercial Code (Livre V, Titre I - Des effets de commerce, in particular art. L. 511-1 et seq.)
• Monetary and Financial Code (Articles relating to cheques and the assignment of professional claims, L. 313-23 et seq.)
• Key case law on the validity of pro forma drafts, bills of convenience and cheque discounting.