Promissory Note: Definition, Types, Characteristics, Pros and Cons

Promissory Note: Definition, Types, Characteristics, Pros and Cons

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Rashmi
Rashmi Karan
Manager - Content
Updated on Dec 27, 2023 17:28 IST

A promissory note is a legal lending document. This document promises to pay a stated amount to someone. It includes the conditions the debtor promises to the counterparty (the creditor), the fixed amount of money as payment, and the period to make it. The promissory note is a title of credit that establishes a formal commitment. Learn what a promissory note is, its parts, types, parties involved, features, advantages, and disadvantages.

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Parties Involved

Usually, the following subjects are involved in the issuance of a promissory note: 

  • Issuer: The one who agrees to pay the agreed amount.
  • Beneficiary: The recipient of the amount, the person who receives the document that commits the issuer.
  • Guarantor: There are occasions when a third subject intervenes in the credit title of the promissory note. This person is in charge of guaranteeing that he will pay the agreed amount and is called a guarantor.

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Parts of a Promissory Note

For a promissory note to be considered correctly issued and to be protected within the law, it must contain these nine specifications:

  1. Date and place of issuance of the promissory note.
  2. Name of the entity and issuing office.
  3. Full name or business name of the beneficiary.
  4. Amount expressed in numbers and letters.
  5. Date and place of the expiration
  6. Account number and International Bank Account Number (IBAN) code of the issuer’s account
  7. The word “I will pay.”
  8. Identifier of the truncation bar. This bar allows computerizing the promissory note.
  9. Issuer’s signature.
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Characteristics of a Promissory Note

Literality

The payment requirement will be limited to what is stipulated in the document. The promissory note must be paid on the agreed date, and the amount will be the one stated in the promissory note. Anything that happens after the issuance, such as arrangements, “deals,” or extensions, will not have any effect if it is not stipulated in the issuance.

Autonomy

The promissory note can change the beneficiary if the beneficiary so wishes. In this way, the new beneficiary will become the new owner of the document and, together with him, will obtain the right to payment. The issuer will be excluded from the right of endorsement.

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Circulation or translation

This right refers to the fact that a document can circulate freely and change ownership. The creditor of the promissory note may change over time, and the last holder may demand payment, even if the subscriber does not know the creditor.

Abstraction

The promissory note will persist and be enforceable independently of the cause that originated it. This private document appears as the beginning and end of an obligation, not an accessory document to another legal act. A promissory note can always be collected unless it is returned or destroyed when the deal is undone. If this does not happen, it will be difficult for the debtor to get out of a commercial lawsuit.

Incorporation

To exercise and claim the rights and obligations associated with the promissory note, it must exist and be able to be displayed.

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Types of Promissory Notes

The type of a promissory note is determined according to its function, mode of issuance, or method of collection. In response to this, its most recurring modalities are:

According to the issuer According to the clause “to order” Depending on the time of payment According to the payment method
Bank promissory note I will pay to order I will pay on sight I will pay to credit the account
Company promissory note I will pay not to order I will pay on a fixed and determined day Cross promissory note
    Variable-term promissory note at issue date  
    I will pay without expiration  

Let’s understand these in detail – 

According to the issuer

Depending on the issuer, a promissory note can be a bank or company.

Bank promissory note – The bank grants a bank promissory note. It is formalized through a document establishing the payment commitment before expiration.

Company promissory note – This is issued by a company or business, where requirements are established for the promissory note to become effective.

According to the clause “to order.”

According to its clause, a promissory note can be to order or not to order.

I will pay to order – When dealing with a promissory note, the beneficiary can grant it to a third party through an endorsement, thus transmitting the rights to collect.

I will pay not to order – Unlike the payable note, the non-payable promissory note cannot be endorsed; however, they can be transferred by credit assignment.

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Depending on the time of payment

Depending on the time, the payment is made on a fixed day with a variable term.

Pay on sight – It is paid when it is presented for collection.

I will pay on a fixed and determined day – It has a specific date for its expiration and payment requirement.

Pay without expiration – It does not have a stipulated or written expiration date inside the promissory note. This is fulfilled when the payment is made.

Variable-term promissory note at issue date – The expiration date is specified when the collection is made in this promissory note.

According to the payment method

Depending on the form of payment, the promissory note will be to pay to the account or crossed.

I will pay to credit the account – It can only be charged if the payment is made by deposit in an account.

Cross promissory note – Cross promissory note is charged at the window if the person carrying it is a client of the entity where it is released.

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Advantages of Promissory Notes:

Among the advantages are:

  • Automated payment to your suppliers
  • You can send the file indicating a future processing date (maximum 60 days), so you can go on vacation, leaving the issue of your payment commitments resolved.
  • Save time and costs by eliminating administrative tasks by freeing yourself from managing your payments, handling documents, and issuing communications to Suppliers.
  • Get information about any change in the status of your payment remittance or message confirming the debit in your payment account via SMS or email.

With a promissory note, the paying bank assures the beneficiary that the promissory note is issued from an account with funds in which the nominal amount of the promissory note is retained, which ensures that it will be honored when the bill expires. This modality adds another degree of reliability. 

Disadvantages of Promissory Note

  1. Low liquidity: The promissory notes are listed on the secondary market.
  2. Unsecured: If the issuing bank has problems, the only guarantee of the promissory notes is the bank's solvency, being able to lose the money in case of bankruptcy.
  3. Higher risk: The promissory notes are not attached to the Deposit Guarantee Fund or Investment Fund.
  4. Minimum amount: Banks normally require more money than in other Savings and Investment products.
  5. Cancellation commission: Banks may apply commissions if clients want to recover their capital before expiration.

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FAQs - Promissory note

Is a promissory note the same as an IOU (I Owe You)?

No, a promissory note is more formal and legally binding than an IOU. While both acknowledge a debt, a promissory note includes specific repayment terms and is often used for more significant financial transactions.

Are promissory notes always used for loans between individuals, or can they also be used in business transactions?

Promissory notes can be used in both personal and business transactions. They are common in various financial agreements, including loans, real estate transactions, and business contracts.

What is the difference between a secured and unsecured promissory note?

A secured promissory note is backed by collateral, such as real estate or assets, which the lender can claim if the borrower defaults. An unsecured promissory note does not have collateral and relies solely on the borrower's promise to repay.

Are promissory notes transferable to other parties?

Yes, promissory notes can be transferred to other parties through a process known as endorsement. The new note holder becomes the payee entitled to receive the payments specified in the note.

What happens if a borrower defaults on a promissory note?

Suppose a borrower defaults on a promissory note. In that case, the lender has legal recourse to seek repayment through various means, including legal action, collections, or foreclosure (in the case of a secured note). The specific actions depend on the terms of the note and applicable laws.

About the Author
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Rashmi Karan
Manager - Content

Rashmi is a postgraduate in Biotechnology with a flair for research-oriented work and has an experience of over 13 years in content creation and social media handling. She has a diversified writing portfolio and aim... Read Full Bio