A promissory note is a form of negotiable instrument which is differentiated from drafts in its elements and function. The two primary forms of negotiable instrument are drafts and notes, with the difference being that promissory notes are promises, not orders like drafts. An order, by definition, involves three parties, while a promissory note need only involve two parties, the maker and the payee. A promissory note also serves a very different function from drafts, as promissory notes are focused on obligations and debts, instead of simply on payments.
- It should be in writing
- It is an unconditional undertaking / promise to pay
- It should be signed by the maker / issuer. Remember it involves only 2 parties – the maker and the payee.
- Payable to both bearer and order of the instrument
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.
Important Points to Remember about Promissory Notes
- A Promissory Note is issued under Section 4 of the Negotiable Instruments Act, 1881
- Promissory Notes issued in one Indian state can be presented in another state provided that the note bears the valid stamp. There is no requirement for additional stamp duty to be paid.
- A Promissory Note must always be written by hand. It must include all the mandatory elements such as the legal names of the payee and maker’s name, amount being loaned / to be repaid, full terms of the agreement and the full amount of liability, beside other elements.
- The note must clearly mention only the promise of making the repayment and no other conditions.
- After issuance, a Promissory Note must be stamped according to the regulations of the Indian Stamp Act. The common practice is to use a revenue stamp on the note which is then signed by the promissory and/or cross signed by the borrower.
- A Promissory Note can also be issued on a Stamp paper in case revenue stamps are unavailable.
- The ideal way to lend money is via issuing crossed account cheques. Details of the cheques can be mentioned in the note.
- All Promissory Notes are valid only for a period of 3 years starting from the date of execution, after which they will be invalid.
- There is no maximum limit in terms of the amount which can be lent or borrowed.
- The issuer / lender of the funds is normally the one who will hold the Promissory Note. When the loan amount has been disbursed or repaid fully, the Promissory Note must be cancelled and marked as “Paid in Full”, after which it can be returned to the borrower / payee.
- While the signature of a witness is not a mandatory requirement, it is advisable to have a note signed by a witness who is independent from the transaction.