Let’s Explore What is Promissory Note with Examples
A promissory note is a legally binding financial document where one party (the issuer or maker) promises to pay a specific amount of money to another party (the payee) at a predetermined date or on demand. Widely used in both personal and professional financial dealings, promissory notes outline key details such as the loan amount, interest rate, repayment schedule, and terms of repayment. These documents ensure transparency and act as enforceable evidence in case of disputes, making them a crucial tool in financial agreements.
Whether it’s a simple loan between friends or a large business transaction, a promissory note adds security and clarity, protecting the interests of both parties involved. From individual lenders to large financial institutions, the use of promissory notes simplifies the lending process and ensures accountability. Understanding their structure and legal importance is vital for anyone involved in financial agreements.
Promissory Note Sample:
I, Ram Kumar, residing at 123, Main Street, New Delhi, promise to pay Shyam Gupta the sum of Rs. 5,000 on or before 15th March 2024 with an interest rate of 5% per annum.
Signed,
Ram Kumar
Date: January 1, 2024
In this example:
Ram Kumar is the drawer who promises to pay.
Shyam Gupta is the payee who will receive the payment.
The amount is Rs. 5,000, and the due date is 15th March 2024.
Types of Promissory Notes
Promissory Notes can be Divided into Four Types, Which Include –
Commercial Note: This is a promissory note or legal document involving an individual and a commercial lending company, such as banks and non-banking financial institutions. For instance, if Mr X avails education loan from a bank, he would need to sign such a promissory note, indicating that he intends to repay the outstanding amount along with interest within a specified tenure.
Personal Note: When an individual seeks credit from friends or relatives, any legal document establishing the repayment of that loan is known as a personal promissory note. However, in most cases, people lending to close relatives or friends overlook such a legally binding document for the transaction.
Investments: A business firm may use a promissory note to procure funds for its operations. Such a move is governed by standard securities laws. Also, this document includes terms and conditions related to the return of the said investment
Real Estate: In case of such a promissory note, failure to repay the promised sum within a stipulated time can lead to the note’s issuer losing possession of his/her immovable property. Alender, on the other hand, is free to recover this sum by selling or acquiring this property in question.
Parties Involved in a Promissory Note
A promissory note typically involves three key parties:
Drawer (Maker):
The drawer is the individual who creates and signs the promissory note, committing to pay a specific sum of money to the payee by a certain date. The drawer is also referred to as the "maker."
Example: If Ram writes a note promising to pay Shyam Rs. 5,000, Ram is the drawer.
Drawee:
The drawee is the person or entity to whom the payment is promised. In most cases, the drawee is also the payee unless the note is transferred to a third party.
Example: In the case above, Shyam is the drawee as he is the recipient of the promised payment.
Payee:
The payee is the person designated to receive the payment under the terms of the note. If the note is transferable, the payee can assign the note to someone else.
Example: If the note is transferred to Rohan, Rohan becomes the payee.
Features of a Promissory Note
Promissory note format remains unchanged regardless of where or how such a document is issued. Here are some features of these notes.
Promissory Notes are Express Undertakings: This signifies that promissory notes are not just a simple acknowledgement of paying a certain sum within a specified time. Instead, it is an express undertaking, meaning that breaching the same could lead to legal consequences and other disciplinary actions.
For example, if Mr A writes that he owes Mr B Rs.10000; it does not automatically become a promissory note. Such a document must be bound by law.
Always in Written Format: Promissory notes are written tenders. Therefore, it cannot exist as an oral agreement. This is one of the basic requirements for this document.
Must Mention Specific Monetary Amounts: Every promissory note should show a specific amount of money that the issuer must repay within the specified time. Once such a note is signed, none of the parties involved in the agreement can change, add or subtract from the sum mentioned. Moreover, the mentioned sum needs to be a particular figure and not an approximate value of the debt.
Only Legal Tender Allowed: Promissory notes can only promise repayment in the form of rupee or dollars or any other currency. It cannot, however, promise repayment in kind. Therefore, in case of a promissory note in India, the issuer needs to repay the sum in the nation’s legal tender, the Indian Rupee.
Mandatory Inclusions of a Promissory Note
A Typical Promissory Note Format in India Includes the Following Information –
Names of all Parties Involved – Such a document must include the names of the payee, drawee, and holder.
Address and Contact Details – Should include the residential address and phone number of all parties involved.
Promissory Note Amount – It must show the sum that is outstanding and must be repaid as per the note.
Repayment Date – This refers to the specified period within which the sum mentioned in the promissory note must be repaid to the lender.
Repayment Terms – The documents should include detailed repayment process for the said sum. Additionally, it must also include penalties or repercussions for late or missed payments.
Collateral Agreement – A promissory note example where the borrower pledges collateral is a real estate note. In such a case, the lender can take possession of an immovable property belonging to the borrower in case the borrower fails to repay the debt within the predetermined period.
Interest Rate – If the lender is charging interest on the borrowed amount, the exact rate at which interest is being levied on the sum must be mentioned in this document as well.
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Promissory Note Format in India
Date: [DD/MM/YYYY]
Place: [City, State]
For Value Received, I/We, [Name of the Drawer], residing at [Address], do hereby promise to pay to [Name of the Payee], residing at [Payee’s Address], the sum of [Amount in Words] ([Amount in Figures]) on [Date of Maturity] with interest at the rate of [Interest Rate] per annum.
Promissory Note Validity
A promissory note is a written promise to pay a specific amount of money on demand or at a future date. To be valid and legally enforceable, it must meet certain requirements:
Written Form: The note must be in writing.
Unconditional Promise: It must contain an unconditional promise to pay a certain amount.
Clear Parties: The drawer (maker), drawee (payer), and payee (recipient) must be clearly identified.
Specific Amount: The exact amount to be paid must be stated.
Payment Date: A specific repayment date or timeframe must be mentioned.
Signature: The drawer must sign the note.
Legal Purpose: The transaction must be legal.
Stamp Duty: It may require proper stamp duty, depending on local laws.
Additionally, the note may have a validity period (e.g., 3 years), and must be presented for payment within that time. Any issues, like unclear terms or lack of signature, can invalidate the note. It is essential to ensure all legal requirements are followed for the promissory note to be enforceable.
FAQs on Promissory Note: Features, Uses, and Examples
1. What is a promissory note and can you provide a simple example?
A promissory note is a legally binding financial instrument in which one party, known as the maker or drawer, makes a written and unconditional promise to pay a specific sum of money to another party, the payee, either on a specific future date or on demand. It serves as formal evidence of a debt.
Example: I, Suresh Mehta, promise to pay Priya Sharma the sum of ₹10,000 on or before December 31, 2025.
2. What are the essential features that must be included in a valid promissory note?
For a promissory note to be legally valid as per the Negotiable Instruments Act, 1881, it must possess the following features:
- In Writing: The promise must be written, not oral.
- Unconditional Promise: The promise to pay must be absolute and not dependent on any condition.
- Specific Amount: The amount payable must be certain and clearly stated in both figures and words.
- Identifiable Parties: The names of the maker (debtor) and the payee (creditor) must be clearly mentioned.
- Signed by the Maker: The note must be signed by the person promising to pay.
- Payment in Legal Tender: The payment must be promised in the legal currency of the country.
3. What are the main types of promissory notes used for different purposes?
Promissory notes can be classified based on their use case:
- Personal Promissory Note: Used for loans between individuals, such as friends or family members.
- Commercial Promissory Note: Issued when borrowing from a financial institution like a bank or a commercial lender for business purposes.
- Real Estate Promissory Note: Used in property transactions, where the property itself often acts as collateral against the loan.
- Investment Promissory Note: Issued by a business to raise capital from investors, functioning as a promise to repay the investment with returns.
4. How is a promissory note different from a bill of exchange?
While both are negotiable instruments, they differ fundamentally. A promissory note is a promise to pay made by the debtor. In contrast, a bill of exchange is an order to pay drawn by the creditor, directing the debtor to pay a certain sum. In a promissory note, there are two parties (maker and payee), whereas a bill of exchange involves three parties (drawer, drawee, and payee).
5. Who are the different parties involved in a promissory note?
A promissory note primarily involves two key parties:
- The Maker (or Drawer): This is the person who creates and signs the note, promising to pay the specified amount. The maker is the debtor.
- The Payee: This is the person to whom the promise of payment is made. The payee is the creditor who will receive the money.
6. What makes a promissory note a legally enforceable instrument in India?
A promissory note's legal enforceability stems from its compliance with the Negotiable Instruments Act, 1881. Its status as a written, signed document containing an unconditional undertaking to pay a certain sum of money makes it a valid contract. Furthermore, for it to be admissible as evidence in a court of law, it must be properly stamped according to the Indian Stamp Act. This combination of a clear promise and legal formalities gives the payee the right to sue for recovery if the maker defaults.
7. What happens if the maker of a promissory note fails to pay the amount on the due date?
If the maker defaults on the payment by the due date, the note is considered dishonoured. The payee or the holder of the note has the right to take legal action against the maker. They can file a civil suit in a court of law to recover the principal amount, along with any specified interest and associated legal costs. The promissory note serves as the primary evidence of the debt in such proceedings.
8. Why is an 'unconditional promise to pay' such a crucial feature of a promissory note?
The 'unconditional' nature is the cornerstone of a promissory note's reliability and negotiability. If the promise to pay were dependent on a future event (e.g., "I will pay if my business makes a profit"), it would introduce uncertainty. This would defeat its purpose as a reliable credit instrument. An unconditional promise ensures that the obligation to pay is absolute, making the note a trustworthy and transferable financial tool.
9. What is the validity period for taking legal action on a promissory note in India?
In India, the period for enforcing a promissory note through legal action is governed by the Limitation Act, 1963. The payee must file a lawsuit for recovery of the amount within three years from the date of maturity or the date the note was executed if payable on demand. If legal action is not initiated within this timeframe, the debt becomes time-barred, and the right to recover the money through court is lost.
