What is a Promissory Note?
A promissory note is a written and signed unconditional promise made by a borrower to pay a certain sum of money to a specified party. This party may be a person or company.
Promissory notes are governed by the Bills of Exchange Act.
Why Should I Write a Promissory Note?
Promissory notes are considered contracts and are legally enforceable.
As a borrower or lender, it would be prudent to agree to drawing up a promissory note. This is because, the promissory note would set out with certainty the exact sum of the loan and the terms of repayment.
Having such clear terms would prevent disagreements between parties from arising in the future.
For example, the borrower may deny owing money to the lender, or the lender may demand a lump-sum payment despite the parties previously agreeing that repayments are to be made in monthly instalments.
In such circumstances, the promissory note, if well-written, could be used as an avenue of legal recourse (e.g. if the promissory note clearly states that the borrower has borrowed a certain sum from the lender, and that repayments are to be made in monthly instalments).
How Do I Write a Promissory Note and When is it Valid?
A promissory note must specify the certain sum of money to be repaid and include a specified time or event for when the money must be repaid.
1. Specified time or event
The specified time or event may be agreed beforehand by both parties before the borrower signs the promissory note and delivers the note to the lender.
The promissory note will only be considered valid after it has been delivered to the lender.
Alternatively, if the borrower is writing the note, he may specify the time or event for when the money has to be repaid, and the lender can decide whether such terms are acceptable to him before the borrower signs on the note.
2. Mode of repayment
A promissory note may also set out the modes of repayment. For example, whether the sum owed would be repaid with a lump sum or through monthly instalments.
Although including a term(s) on the mode of repayment is not strictly required by the Bills of Exchange Act, doing so may prevent the lender from later demanding a mode of repayment you are unable to comply with (as mentioned above).
3. Witnesses or guarantor
It is not compulsory to have a witness or guarantor for a promissory note to be valid. However, having a witness may be a wise option to show that the agreement was made fairly and without any coercion.
This would protect both parties against allegations by the other party of duress (i.e. improper pressure via threats), undue influence or mistake by the borrower, since a witness may testify on whether the agreement had been made fairly.
4. Agreeing on how to enforce late payment
The promissory note may also include the terms for actions to be taken against the borrower in the event that repayment is not made.
Although such terms are not necessary for a promissory note to be legally valid, agreeing on the modes of enforcement would be beneficial for both parties since they would know what to expect in the event where repayment is not made.
For example, the terms of enforcement could state that if the monthly payment is overdue, the borrower must pay a late charge or pay immediately the full amount overdue to the lender.
Such terms could also be enforced instead of the lender immediately seeking legal action (and expending legal costs) to recover the sum of money owed to him.
Should the borrower not comply with the terms of enforcement, only then would the lender need to seek legal action (see below for the remedies available).
Secured and Unsecured Promissory Notes
There are various types of promissory notes.
A secured promissory note is one where the borrower provides security or collateral in exchange for receiving the loan. Valid security or collateral includes any valuable property owned by the borrower.
In the event that the borrower does not follow the repayment terms of the promissory note, the security or collateral may be sold to repay the loan.
Do note that certain securities may require registration under section 131 of the Companies Act (CA).
These securities include:
- Charges to secure the issue of debentures
- Charges on the book debts of the company
- Floating charges on the property of a company
- Charges on intellectual property rights
If such charges are not registered within 30 days of creation in accordance with the requirements of section 131(1) of the CA, these securities cannot be enforced by the lender because they would be considered void.
Conversely, an unsecured promissory note is where the borrower does not provide security or collateral in exchange for receiving the loan.
Unsecured promissory notes rank lower than secured promissory notes in terms of the priority of repayment.
Meaning, in the event where the borrower is unable to repay his debts to all his lenders, lenders with security are able to claim the money raised from the sale of the borrower’s security first, before the excess money (if any) is distributed to lenders without security.
Are Promissory Notes Legally Binding?
Yes, promissory notes are legally binding because they are contracts.
In fact, the court treats these notes like cash. Thus, if a borrower refuses to pay according to repayment terms of the promissory note, it is possible for the court to enter a speedy judgment against the borrower and allow the lender to enforce payment of the unpaid promissory note relatively quickly.
Differences between Promissory Notes, IOUs, and Bills of Exchange
Besides promissory notes, there are other simple loan agreements like IOUs and bills of exchange. These instruments are different from promissory notes.
An IOU is an informal acknowledgement of a debt owed. It is less formalistic than a promissory note and does not have strict requirements as to how it must be structured. This informal nature may result in uncertainty as to whether the IOU is a valid, legally binding contract.
On the other hand, a promissory note is a more formal instrument governed by the Bills of Exchange Act, where the borrower makes a written promise to pay the lender a certain sum of money.
A bill of exchange is also governed by the Bills of Exchange Act, but it is sort of like a “reverse” promissory note. This is because, instead of the borrower making a written promise to repay the lender, a bill of exchange involves the lender making an unconditional written order for payment that is addressed to the borrower.
However, the bill of exchange does not need to be delivered in order to be considered valid.
Can I Charge Interest in a Promissory Note?
Yes, you may charge interest in a promissory note. In fact, there is no maximum interest rate you can charge.
Although Singapore law prescribes a maximum interest rate for licensed moneylenders under the Moneylenders Rules, this only applies to those in the business of moneylending.
If you can prove that you are not in the business of moneylending, there is no maximum interest rate.
Can the Terms of a Promissory Note be Changed After being Signed?
Yes, the terms of the promissory note may be modified post-agreement.
Modifications must be mutually agreed by both parties and the new agreement should be signed and dated by both parties to show that both parties have agreed to the modifications.
What If the Borrower Fails to Repay the Debt Within the Deadline?
When the sum of money is due under the terms of repayment of the promissory note, the lender has the right to present the note to the borrower for repayment within a “reasonable time.”
There is no strict rule on what is the exact length for a “reasonable time”, but the court would consider the circumstances around which the agreement was reached, industry practices and any other relevant facts.
If the borrower still fails to make repayment, the lender has the following options available to him:
- For secured promissory notes, the security or collateral put up by the borrower may be used to repay the loan.
- For unsecured promissory notes, the lender may seek legal action against the borrower to enforce the loan.
Such legal action may include bringing about bankruptcy or winding up proceedings against the borrower so that the borrower’s assets would be distributed to the lender, or obtaining a court judgment to compel payment.
You may refer to our article on debt recovery to find out more about the possible legal actions.
A promissory note adds certainty to loans and repayment for both lenders and borrowers.
Should you require assistance in drafting a promissory note, please feel free to contact me.