What Is a Promissory Note and When Is It Appropriate?

A promissory note allows one person (‘the issuer’) to promise, in writing, to pay an agreed sum to another person (‘the payee’). Although a promissory note is a simple and straightforward document, it is not appropriate for all circumstances where you are borrowing or lending money. It is also not to be confused with a loan agreement.

This article explains:

• what a promissory note is;
• the key terms it will contain; and
• the differences between a promissory note and a loan agreement.

What Is a Promissory Note?

A promissory note is an instrument under which the issuer of the promissory note unconditionally promises in writing to pay an agreed sum to the payee. The issuer will make this payment either on:

• demand; or 
• a specified date. 

Promissory notes can be useful for parties who have a close and trusting relationship and where the sum of money is relatively low. In these situations, the parties likely do not want to negotiate a long, complex and costly loan agreement. 

Key Terms of a Promissory Note

A promissory note is a simple, straightforward document. Its key terms include:

• who the parties are (i.e. who is promising to repay the money and who will be receiving the repaid money);
• when the sum is repayable;
• whether any interest is payable on the sum;
• whether the promissory note can be transferred to another party; and
• the signature of the party issuing the convertible note.

What Is the Difference Between a Promissory Note and a Loan Agreement?

Although promissory notes and loan agreements are both used in contexts where somebody intends to borrow and subsequently repay a sum of money, they are very different.

A promissory note is far simpler than a loan agreement. 

A loan agreement also provides the lender with greater protection and contains far more complex terms, such as:

• when and how the borrower will receive the loan;
• any conditions that the borrower must meet;
• more complex repayment terms (e.g. repayment in instalments);
• representations and warranties by the borrower;
• ‘events of default’ that would cause the loan to be immediately due; and
• any undertakings by the borrower (e.g. promising to comply with relevant laws).

A promissory note is unlikely to be sufficient if you are:

• dealing with a party you are unfamiliar with; or 
• lending a large amount of money.

In these circumstances, you may require the protection and clarity of a comprehensive loan agreement.

Key Takeaways

A promissory note is a straightforward document which can be useful where:

• you are promising to pay a certain, relatively low sum of money; and 
• the transaction is low risk. 

Promissory notes do not offer a lot of protection for the person owed money. Therefore, where protection is required, you may need a comprehensive loan agreement instead. If you add more complex terms to a promissory note, it may cause it to become a more complex financial product and therefore fall within the scope of certain regulations (such as the Corporations Act or the National Consumer Credit Protection Act). In these situations, you should ask a lawyer to review your promissory note to ensure it is appropriate for your circumstances. If you require assistance with preparing a promissory note or a loan agreement, contact LegalVision’s banking and finance lawyers on 1300 544 755 or fill out the form on this page.