Table of Contents
What is a promissory note?
It is defined under section 4 of the Negotiable Instrument Act 1881. It is a financial instrument that contains a promise, in writing, by one person to pay a specific amount of money to another person, either on specifying the date or on the demand or person and it should be unconditional and signed by the drawer. The promissory note consists of all the conditions, amount, interest rate, dates, and the signature of the person in it. It should be noted that it is not a banknote or currency note.
In simple words, it is a written promise by a person to pay a certain amount of money on a specific date or the demand of another person. Let’s try to understand this, for example, A, an individual writes on a paper that he will pay the 1000 Rs to B on his birthday on the date 24 May of this year. Here, the paper where he wrote his promise is a promissory note.
Parties in the Promissory Note
There are mainly three parties in the promissory note, such as drawee, payee, and drawer. These three parties have a different role in it. Let’s understand the means of these three.
Drawer- The person who makes the written promise on the instrument to pay the money on a certain date or demand is called the drawer. It is also known as, payer, debtor, maker, promisor, or issuer.
Drawee- The person to whom the promise has been made is known as the Drawee.
Payee- He is a third party where the drawer will pay the money to him on the order of the drawee.
Essentials of Valid Promissory Note
- Printed/Written Agreement – It should be properly written or printed. Any oral promise made by the person is not accepted as a promissory note.
- Unconditional Promise – The promise made by the drawer to the drawee must be unconditional there should not be any conditions fixed in the pronote. The condition made by the drawee to pay the money to the payee can be added to the promissory note.
- Signed Documents – the document must be signed by the drawer. The drawee doesn’t need to sign the same because it is the liability of the drawer, not the drawee.
- Exact names- there must be the exact names of all the parties.
- Interest– if there is any interest rate is applied to the money then it should be mentioned in the pronote.
- Date of issue- the date of issue and the mature date must be specified in the pronote.
- Stamped- the document must be stamped. There can be a revenue stamp of one rupee or the pronote should be on the stamp paper.
- Pay Defined Amount – the total amount which is written in the pronote should be paid by the drawer. The amount written cannot be subtracted or added.
- Legal Composition – The payment should be made in the legal currency.
- Detailed Information – All the information should be in detail.
All these are the Essentials of a Valid Promissory Note.
Types of Promissory Note
Promissory notes come in various forms, each serving a different purpose. Here are some common types of the Promissory note:
Simple Promissory Note
A simple promissory note is straightforward. It specifies the amount of money to be repaid, the interest rate, and the repayment date. It’s typically used for straightforward loans between individuals.
Demand Promissory Note
This type of note allows the lender to demand repayment at any time. There’s no fixed repayment date. The borrower must repay the loan whenever the lender asks for it.
Installment Promissory Note
An instalment promissory note outlines a repayment schedule with specific amounts due at regular intervals. It’s often used for personal loans or financing purchases, such as buying a car or home.
Commercial Promissory Note
Commercial promissory notes are used in business transactions. They may involve larger sums of money and more complex terms than personal PNs. Businesses often use these notes to secure financing or investments.
Secured Promissory Note
A secured promissory note is backed by collateral. If the borrower fails to repay the loan, the lender can claim the collateral as compensation. This reduces the risk for the lender.
Unsecured Promissory Note
Unlike a secured note, an unsecured promissory note has no collateral. The lender relies solely on the borrower’s promise to repay. These notes are riskier for lenders but are often used when there’s a high level of trust between the parties.
Convertible Promissory Note
A convertible PN can be converted into equity or shares in the borrower’s company. This type is common in startup financing, where investors might want to switch their loans into ownership stakes.
Each type of PN serves a specific need, providing flexibility and clarity in financial agreements. Understanding these different types helps ensure that the terms of a loan or financial transaction are clearly defined and legally enforceable.
Features of Promissory Note
- The money can be payable in instalments or a lump sum
- It can be interest-bearing or interest-free
- The pronote can be of single or joint borrowers; which means there can be multiple persons in one pronote.
- It can be negotiable on the demand or order or drawee.
Remedies for Non-payment of a Promissory Note
If someone does not pay back the money promised in a PN, there are several remedies available to the person who is owed the money. Here are the steps they can take:
Legal Notice
The first step is to send a legal notice to the person who owes the money. This notice is a formal way of reminding them about their obligation to pay. It usually sets a deadline for payment and warns of further legal action if the payment is not made.
Filing a Lawsuit
If the person still does not pay after receiving a legal notice, the next step is to file a lawsuit. The creditor can take the matter to court by filing a suit for recovery of the amount specified in the PN. The court will then examine the case and, if it finds in favour of the creditor, it will order the debtor to pay the money.
Obtaining a Court Decree
Once the court decides that the debtor must pay the money, it will issue a decree. This decree is a formal order from the court that the debtor must pay the amount due. If the debtor still does not pay, the creditor can take further steps to enforce the court’s order.
Execution of Decree
If the debtor does not comply with the court’s decree, the creditor can request the court to enforce the decree. This may involve seizing the debtor’s property, garnishing their wages, or taking other legal steps to recover the money owed.
Negotiating a Settlement
Sometimes, it is possible to reach an agreement outside of court. The creditor and debtor can negotiate a settlement where the debtor agrees to pay a portion of the debt or arrange a new payment plan. This can save time and legal costs for both parties.
Using Alternative Dispute Resolution (ADR)
ADR methods like mediation or arbitration can also be used to resolve disputes over promissory notes. These methods are often faster and less expensive than going to court. An impartial third party helps the creditor and debtor reach an agreement.
Reporting to Credit Agencies
In some cases, the creditor can report the non-payment to credit agencies. This can negatively affect the debtor’s credit score, making it harder for them to get loans or credit in the future. This can sometimes encourage the debtor to pay the outstanding amount.
These remedies help ensure that the person who is owed money on a promissory note can take steps to recover their funds. Creditors need to know their rights and the legal options available to them in case of non-payment.
Landmark Cases Related to Promissory Notes
Bharat Barrel & Drum Manufacturing Co. v. Amin Chand Pyarelal (1999)
This landmark case, decided by the Supreme Court of India, revolved around the validity of promissory notes and the nature of consideration. In this case, Bharat Barrel & Drum Manufacturing Co. issued a PN in favour of Amin Chand Pyarelal. The PN was challenged on the grounds of absence of consideration. The Supreme Court held that the PN is a prima facie evidence of consideration and the burden of proof lies on the party denying the consideration to prove its non-existence. This case established the principle that a PN inherently implies the existence of consideration unless proven otherwise.
K. Narasimha Rao v. Lakshmi Narasimha Rao (2002)
In this case, the Andhra Pradesh High Court dealt with the issue of enforceability of a promissory note. The plaintiff, K. Narasimha Rao, filed a suit for recovery of money based on a promissory note executed by the defendant, Lakshmi Narasimha Rao. The defendant contended that the promissory note was executed under duress and without free consent. The court emphasized that for a promissory note to be enforceable, it must be executed with free consent and without any coercion. The judgment underscored the importance of voluntary execution and the significance of intent in the enforceability of promissory notes.
Conclusion
In conclusion, a promissory note is a crucial financial instrument that serves as a formal promise to repay a specified amount of money. It ensures clear communication and legal accountability between parties involved in a financial transaction. Understanding the consequences of non-compliance, as illustrated by landmark cases, highlights the importance of adhering to the terms of a promissory note. In cases of non-payment, several remedies are available, ranging from sending a legal notice to seeking alternative dispute resolution. These remedies provide a structured approach to recovering owed money, ensuring that creditors can protect their financial interests. Overall, a promissory note’s legal framework supports fair and transparent financial dealings, fostering trust and reliability in financial transactions.