Promissory Notes: Meaning, Features, Elements, Types, Advantages and Disadvantages

Meaning of Promissory Note

Promissory note refers to legal and financial document containing written promise made by one party to pay another party a specific amount of money, either on demand or at fixed determinable future time. It is a type of lending document that is more commonly used for borrowing or lending of short-term credits by people. This short-term credit tool is not concerned with any banknote or currency note. Promissory note is also known as notes payable, binding the borrower by law to pay back particular amount of money to lender on specified date or on demand under certain conditions. These are basically negotiable instruments governed by Negotiable instruments act, and can be of distinct types such as with one or multiple borrowers, payable in instalments or on demand, payment to be done in lump, either with interest or without interest. 

This note includes all terms concerned with indebtedness such as name of both parties, principal amount, interest rate, maturity date, place of issuance, signature of issuer and other terms of repayment. In case, if any collateral is used then it may also be stated in term and conditions. The promissory notes too like other legal lending documents have validity of 3 years, beginning from the data of execution and post of this they become invalid. After issuance, the promissory note needs to be stamped as per the provisions of Indian Stamp Act and more common practice is using revenue stamp on note.

Features of Promissory Note

The features of promissory notes are as follows: – 

  1. Written/Printed agreement- Promissory note must be necessarily in written form such that no alterations can be brought in it easily. A promise made in verbal form to pay amount is not considered as promissory note.  
  2. Pay defined amount- The note is a promise to pay specific amount of money at fixed future date or on demand. Adding or subtracting any figures from this mentioned amount is not possible.   
  3. Unconditional Promise- Promise to pay certain amount is absolute in all cases and is not dependent upon happening of any outside event or contingency. A conditional guarantee under promissory note is not at all accepted. The presence of any conditional undertaking will destroy the negotiable character of negotiable instrument. 
  4. Signed documents- The promissory note needs to be duly signed and drawn by drawer and stamped. There is no constraint with regard to place or form of signature on instrument. It can be done on any part of promissory note using either a pencil, ink, thumb mark or even initials. 
  5. Legal composition- All payments mentioned in promissory note are done in legal currency of nation. The promise involves payment of legal tender money and not any old or rare coins. All promises involving delivery of goods instead of money payments does not constitute a promissory note.
  6. Detailed information- Promissory note is inclusive of all detailed information regarding transaction such name of both drawer and payee, maturing date, issue date, principal amount, rate of interest, repayment terms, signature of drawer, name of drawee etc.

Elements of Promissory Note

It is must to include all the required elements in promissory note for making it enforceable and legal document. Such elements are as follows: – 

  • Name of all concerned parties Promissory note must comprise of all parties that are part of the transaction: Drawer, Drawee and Payee. 
  • Contact/Address detail of all partiesIt should include the contact number and address of each party associated with transaction. 
  • Amount of LoanThe face amount of money borrowed or lend. 
  • Repayment dateA note should clearly indicate the date on which repayment of loan must be done.  
  • Interest rateIn case if loan involves interest, then promissory note should mention the interest rate that will computed on the basis of annual percentage rate (APR).  
  • Final amount coming after interest additionIn all those cases where interest is charged, note should clearly indicate the final amount payable after interest amount is applied. The final amount will be inclusive of principle amount of loan and interest rate applicable.  
  • Terms of repaymentAll terms governing the repayment of loan, needs to be clearly stated in promissory note.  
  • Collateral HoldThe list of goods or services that are put as guarantee on loan should be mentioned in promissory note along with the value of such collateral items.  
  • Terms of DefaultIt should include the terms applicable in case of borrower’s default whereby he/she fails to make loan payment on time. 
  • SignatureThe signature of borrower and witness need to be compulsorily included in promissory note. However, the inclusion of lender’s signature is mandatory or not is determined as per state laws that differs form each other.   

Types of Promissory Note

The promissory notes are of different types depending upon the type of promissory loan. Such types are mentioned in points given below: – 

  1. Single promissory note- The single promissory note is meant for creating written guarantee that borrowed money will paid back to lender in agreed upon manner. Under this promissory note, the loan purpose need not to be described in detail unlike other types of notes. 
  2. Commercial promissory note- Commercial promissory note is used for borrowing money from commercial money lenders such as financial institution, banks or a loan agency. The lender possesses right of demanding full amount of loan along with interest, in case, if borrower fails to make the required payments. In addition to this, lender can assign lien on borrower’s assets till the time payment is received.   
  3. Real estate promissory note- Real estate promissory note is quite similar to commercial promissory note with regard to non-payment consequences. The borrower uses his/her property as collateral for securing the note. A lender can place lien on assets of borrower, in case, if he/she falls default in doing required payments. If any situation like this takes place, then the information become accessible to public thereby influencing the borrower’s credit. 
  4. Personal loan promissory note- Personal loan promissory note is used for documenting loan among family members or friends. Generally, people avoid any type of legal writing when taking loan from close contacts. But having a written record of loan regardless of how well you know someone can help in unforeseen disagreements.  
  5. Student loan promissory note- A student loan promissory note is termed as master promissory note by government. It is type of agreement under which borrower will pay back the loan amount borrowed for education purposes -along with interest charges.  These types of promissory notes are created generally among government and borrower. However, few students create promissory note with their parents and relatives who pay for their education expenses.   
  1. Car promissory note- Car or Vehicle promissory note refers to an agreement where borrower will do payments of borrowed money to lender in exchange for car. The note comprises of details such as make and model of car, and is kept accessible, in case, if there is a need to prove ownership of car. If property such as car needs to be transferred without asking for payment in return, a gift affidavit helps in legally recording the change of possession.  
  1. Investment promissory note- A investment promissory note serves as substitute of business loan that is used for raising capital for business purposes. It minimizes the risk of business investments via assuring that investors receive return on their investment value over given period of time. The investor carries right of legally taking over the company’s ownership if borrower fails to do money payments. 

Parties to Promissory Note

There are 3 primary parties involved in every promissory note: -Drawee, Drawer and Payee. 

  • Drawer- A drawer is person who makes or issues promissory note and agrees to pay drawee a certain amount of money on maturity date. He/she is also referred to as maker. 
  • Drawee- Drawee is a person in whose favour the note is prepared by drawer. Generally, the same person is also payee unless and until promissory note specifies name of some other person as payee.  
  • Payee- A payee mean person to whom the payment is to be done. 

Under most of the cases, payee and drawee are same peoples to whom payment is made. A promissory note is kept by party providing the loan and on due date, the payee or drawee cancels it and give it to drawer. 

Advantages and Disadvantages of Promissory Note 

The advantages of promissory note are as follows: –   

  • Simple- First major advantage of promissory note is its simplified and straightforward nature. There is no need to record much things and prepare lengthy documents with promissory notes. This makes issuance of such notes an incredibly hassle-free.  
  • Legal binding- Promissory note carries legal binding that is beneficial for person to whom promise of money payment is made. As it is legally binding, therefore once the deal is sealed then money must be paid legally. 
  • Flexibility- A promissory note adds element of flexibility for person borrowing the money. He can make distinct arrangements for making repayments as it is not necessary to do pay lump-sum amount in one go.  
  • Time for repayment- It provides benefits for borrower due to presence of specified time frame for doing money repayments, therefore the deadline is not immediate.  
  • Incorporate needs of both parties- Promissory note incorporates the financial needs of both parties i.e., drawer and drawee. The drawer gets facility of doing payment on deferred date, while drawee also get option of discounting the instrument from bank if immediate price is needed.  

The disadvantages of promissory note are explained below: – 

  • Short-term services only- Major disadvantage of promissory note is that it can be used for availing short-term credit services only. It is of no use for big ventures looking for huge investment amount.   
  • Risky- Promissory note is risky credit instrument for new borrower as unfavourable terms may be hidden in apparent short and simple sentences on it. Consequently, the person who has borrowed sum may be required to pay massive sum for liabilities incurred.  
  • Costly lawyer fees- The lender may need to visit court in case of defaults where drawer fails to make payments. All this involves lawyer fees that are extremely costly, so it is definitely disadvantage for lender.