All About Promissory Note

Neethi V. Kannanth , Last updated: 15 September 2022
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A promissory note is a legal and financial instrument that contains a written promise by one party to pay another party a definite sum of money either on demand or at a specified date in the future. In India it is issued under section 4 of the Negotiable Instruments Act, 1881.

Types of Promissory Notes

A Promissory Note may be secured or unsecured.

In case of a secured note, the borrower will be required to provide collateral such as property, goods, services, etc., in the event that they fail to repay the borrowed amount. The value of the collateral being provided must be more or equal to the amount that is being borrowed.

In case of an unsecured Promissory Note, no collateral needs to be provided. An unsecured loan is easy to get if one has a health credit score.

Depending upon the kind of promissory loan, promissory notes are of different types. Few are mentioned below.

Personal Promissory Notes: This is a particular loan taken from family or friends. Though people avoid legal writings when seeking a loan from close contact, the promissory note shows belief and trust in the interest of the borrower.
Commercial: Here, the note is made when dealing with commercial lenders such as banks. Most of the commercial promissory agreement is similar to personal notes.
Real Estate: This is similar to commercial notes in terms of nonpayment consequences. If the borrower becomes a defaulter, then the party has the right to keep the property until the debt is cleared. It is a little risky as all the essential details become public, which can hinder the borrower’s credit history in the future.
Investments: The promissory note is occasionally used to raise funds for the business. It is used as a security purpose and managed by securities laws. It includes terms and conditions related to returns of investment.

Parties of Promissory Note

All promissory notes constitute three primary parties. These include the drawee, drawer and payee.

Drawer: A drawer is a person who agrees to pay the drawee a certain amount of money on the maturity of the promissory note. He/she is also known as a maker.
Drawee: She/He is an individual, in whose favour the note is prepared. In usual cases the drawee is also the payee until and unless the promissory note is transferred specifically in favour of the payee.
Payee: A payee is someone to whom the payment is made.

Compulsory elements of a Promissory Note

A Promissory Note will only be enforceable if it includes all the elements which are necessary to make it a legal document. To make a Promissory Note enforceable, I must contain the following information.

Names of All Involved Parties -the Promissory Note must include the legal names of all the parties who are a part of the transaction.
Contact /Address Details of All Parties - The note must include the address and contact number of all the parties which are involved in the transaction.
Loan Amount - The loan amount that is being borrowed or lent.
Date of Repayment - The note must clearly state the date on which the repayment for the loaned amount must be paid.
Rate of Interest - In case interest is being charged on the lent or borrowed amount, the note must mention the rate of interest which will be calculated on the basis of APR (annual percentage rate).
Final Amount After Addition of Interest - In case interest is being charged, the note must clearly mention the final amount which is to be repaid after the interest is applied. The final amount will include the principal loan amount + the interest rate applicable.
Collateral Hold / Pledge of Security Agreement - the note must contain the list of goods / services which are being put as a guarantee on the loan and also their value.
Terms of Repayment - The note must have a clear mention of the terms on which the repayment of the loan must be done. Inclusions can also be made for late or missed payments.
Default Terms - The note must clearly mention the terms applicable in case the borrower fails to make the payment of the loan amount on time.
Signature - The note must compulsorily include the signature of the borrower and a witness. Whether the signature of the lender is a mandatory requirement will differ from state to state. However, the signatures of the borrower and witness are of prime importance as without them, the note will be invalid and not have any legal capacity in a court of law.

Validity of Promissory Note

A promissory note is valid for 3 from the date of execution.

Cancellation of Promissory Note

Once the loan amount borrowed is disbursed or repaid in full, the Promissory Note must be cancelled and marked as “Paid in Full” and returned to the borrower or the payee.