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Promissory Note

Promissory Note

Financial transactions always come with some risk. When money and borrowing are involved, you'll want assurance that your money is safe and that you have legal support if things go wrong. That's where the promissory note comes in.

Our expert network of small business lawyers at Lawhive is here to help. Contact our legal assessment team for personalised advice and guidance on promissory notes.

Whether you're a finance expert or new to the field, this article covers everything you need to know about promissory notes.

What is a promissory note?

A promissory note is a legal document in which one party, called the maker or issuer, agrees in writing to pay a certain amount of money to another party, known as the payee, either when asked or on a set future date. It serves as proof that the maker owes a debt to the payee.

Promissory notes are regulated by the Bills of Exchange Act 1882, along with other laws and legal precedents.

What makes a promissory note valid?

For a promissory note to be valid and enforceable, it must meet certain legal requirements set by relevant laws and court rulings. In the UK, these requirements are typically outlined in the Bills of Exchange Act 1882 and other laws. To be valid, a promissory note must:

1. Be written down

2. Include an unconditional promise to pay by the maker, without any conditions or ifs

3. State a specific amount of money to be paid, written out in words

4. Identify both the maker and the payee

5. Be signed by the maker or someone authorised to sign for them

6. Specify a clear due date for payment

7. Mention any applicable interest rate

8. Ensure that both the maker and the payee are legally capable of entering into a binding agreement - meaning they're mentally sound, of legal age, and not restricted by any legal issues.

Promissory notes are frequently used in business deals, loans, small business agreements, and other financial arrangements to document debts and clarify repayment terms. They can be transferred to another party through endorsement and delivery, giving the payee the ability to pass on their rights.

Not keeping your word on a valid promissory note can have legal consequences, possibly leading to legal action. So, make sure you follow the legal rules and think carefully before agreeing to such deals.

If you need more help or advice on promissory notes or any legal issue, it's a good idea to find a qualified solicitor for personalised guidance.

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

In a secured promissory note, the borrower pledges something valuable, like property or a vehicle, as security for the loan.

If they don't pay back the loan, the lender can take this collateral to cover what's owed. This reduces the risk for the lender, especially when the borrower doesn't have strong credit.

An unsecured promissory note doesn't need any collateral from the borrower. They just promise to repay the loan as agreed.

Since there's no collateral, it's riskier for lenders. To offset this risk, they might charge higher interest rates or have stricter lending requirements.

Unsecured promissory notes are common for smaller loans, personal loans, or when the borrower has a good credit history and finances.

Are promissory notes legal in the UK? 

Yes, promissory notes are legal in the UK.

According to the Bills of Exchange Act 1882, a promissory note is a written promise from one person (the maker) to another (the payee) to pay a certain amount of money either immediately or at a later date.

Anyone using promissory notes should make sure they follow the law and get legal advice if they have any questions or concerns.

When do you use a promissory note?

Promissory notes are commonly used when one person (the borrower) owes money to another person (the lender) and wants to make a legally binding promise to repay the debt.

Some common scenarios in which promissory notes are used are:

1. Personal loans: to record the loan details such as the amount borrowed, any interest rate, when it will be repaid, and other important terms.

2. Business funding: When a company gets a loan from a bank, financial firm, or private investor, a promissory note lays out the loan terms, like the amount borrowed, interest rate, when it's repaid, and any collateral used as security.

3. Buying goods or services on credit: In business deals, a seller might offer credit to a buyer. A promissory note can make this credit official, stating how much is owed, when it's due, and any interest or fees involved.

4. Property deals: Especially in cases where the seller offers financing to the buyer, like in seller financing. The promissory note shows the buyer's commitment to repay the loan, often backed by the property being bought.

5. Debt adjustment: When someone can't repay a debt in full, they might negotiate new terms with the creditor. A promissory note can record these new terms, like a lower amount owed, a different interest rate, or a longer repayment time.

Is a promissory note a legally binding document? 

Yes, a promissory note is a legally binding document. Once signed by the borrower and given to the lender, it becomes a contract that can be enforced by law. If the borrower doesn't repay the debt as agreed, the lender can take legal action to get the money back. This might involve going to court, seizing assets, or using other methods to collect the debt. To be legally valid, a promissory note must have certain key elements, like a clear promise to repay, a specific amount, the names of the borrower and lender, and the borrower's signature. Both parties should understand their rights and responsibilities under the promissory note and make sure the terms are clear and enforceable. If there's any confusion or disagreement, it's wise to get legal advice to understand the options available.

Common terms in a promissory note

In a promissory note, several common terms are typically included to outline the rights and obligations of the parties involved. These terms may vary depending on the specifics of the loan agreement, but commonly include:

Why might a promissory note be seen as invalid?

A promissory note might be considered invalid for various reasons, often due to not meeting legal requirements or errors in how the agreement was made. For instance, if the promissory note doesn't include all the necessary elements required by law, like a clear promise to pay, a specific amount, identifiable parties, or a fixed due date, it might be invalid. Also, if the terms are unclear or open to interpretation, it could be seen as invalid. If a signature on the promissory note is forged or obtained without proper permission, the note may be invalidated. All involved parties must be legally able to make the agreement, and signatures must be genuine. A promissory note involving illegal activities or unlawful purposes could be declared invalid. For example, if the loan is for illegal purposes, the note might be invalidated, as well as if it resulted from a mistake or fraud. This includes situations where one party was misled or deceived about the terms or nature of the agreement. Sometimes, a promissory note may be considered invalid if the statute of limitations prevents legal action to enforce it. This refers to the time limit for filing a lawsuit to enforce rights under the promissory note.

Does a promissory note need to be in writing?

Yes, a promissory note must be written to be legally valid and enforceable.

While there's no set format required by law, it's best for the note to be clear, brief, and cover all the terms of the agreement well. This helps ensure both parties understand and reduces the risk of disagreements about its validity.

How to make a promissory note

Creating a promissory note involves drafting a written document that outlines the terms of a loan or debt arrangement between the borrower (maker) and the lender (payee). 

To make a promissory note, you should seek legal advice, particularly for more complex transactions. This will ensure your note meets legal requirements and is valid to stand up in court. 

Who should sign a promissory note?

In a promissory note, the parties involved are typically the borrower (maker) and the lender (payee). Both parties have specific roles and responsibilities, and it's important for each to sign the promissory note to indicate their agreement to the terms outlined in the document. 

The borrower should sign the promissory note to acknowledge their obligation to repay the loan. The lender should also sign the promissory note to indicate their acceptance of the borrower's promise to repay the loan.

In addition to the borrower and lender, there may be other parties who sign the promissory note depending on the specific circumstances of the transaction:

Co-Signer or guarantor: In some cases, a third party may co-sign the promissory note as a co-signer or guarantor. A co-signer agrees to be jointly responsible for repaying the loan if the borrower fails to do so, while a guarantor provides a guarantee of repayment. Both the co-signer and guarantor should sign the promissory note to indicate their commitment to fulfil their obligations under the agreement.

Witness (Optional): Depending on specific requirements or preferences, you may choose to have a witness sign the promissory note to attest to its execution. A witness can provide additional evidence of the parties' agreement to the terms of the note.

Can I buy a house with a promissory note?

Yes, you can include a promissory note in your house purchase financing, although it's not as common as traditional mortgage loans. They can be helpful for those who don't qualify for or have difficulty getting a regular mortgage. A promissory note shows the borrower's commitment to pay back the loan to the seller gradually, usually with details like interest rate, payment plan, and any collateral provided.

Here’s how it can work:

Instead of getting a loan from a bank or mortgage company, you work directly with the seller to buy the house. The seller agrees to finance part or all of the purchase price through a promissory note. You and the seller agree on the details of the promissory note, like the amount borrowed, interest rate, repayment plan, and any collateral. These terms are put in writing in the promissory note. Usually, the promissory note is signed during the house closing process. Both you and the seller sign it, along with other legal papers for the sale. Once the closing is done and the promissory note is signed, you become the owner of the house. You make regular payments to the seller based on what's agreed in the promissory note. This might include monthly payments of the loan amount plus interest until it's all paid off. Buying a house with a promissory note has risks for both you and the seller. As the buyer, you should check out the property carefully and make sure the promissory note terms are fair. The seller should look into your ability to pay back the loan. It's a good idea to talk to legal and financial experts to make sure you follow all the laws and deal with any concerns or problems.

How do you enforce a promissory note?

Enforcing a promissory note means making sure the borrower pays back the money they owe according to the agreement. 

To enforce a promissory note, you should:

1. Look at the note to see what the borrower promised to pay and when.

2. Talk to the borrower and find out if they can pay back the money without going to court.

3. If talking doesn't work, send a formal letter asking the borrower to pay back the money.

4. See if the borrower is willing to make a new plan for paying back the money.

5. If the borrower still doesn't pay, you may need to take them to court. A judge will decide if the borrower owes the money and how to make them pay.

6. If the court agrees the borrower owes the money, they'll issue an order saying so.

7. Use the court order to take action, like taking money from the borrower's wages or assets to get back what they owe.

Do I need a solicitor for a promissory note?

If your promissory note involves large sums of money, complex terms, or extra legal matters like collateral, it's wise to get legal advice. A solicitor can ensure the document is properly written to protect your interests. They can help make sure the terms of the promissory note match what you want and safeguard your interests. They'll also warn you about any potential problems and can negotiate better terms if needed. If the borrower doesn't pay back the promissory note and you need to take legal action, a solicitor can guide you through the legal process and increase your chances of getting back what's owed. When it comes to money and assets, working with solicitor gives you peace of mind that your rights are protected and the promissory note is legally enforceable.

How can Lawhive help?

Lawhive offers access to experienced solicitors who specialise in promissory notes, contract law, finance, and commercial transactions.

Our team of experts can assist you with legal advice, drafting documents, negotiation support, and enforcement help. Contact us today for a free case assessment.