Promissory notes are a useful way to establish a clear record of a loan, whether between entities or individuals, and to put all relevant terms in writing, so that there is no doubt about the amount of money borrowed and when payments are due. Traditionally, lenders used promissory notes as proof (i.e. However, with the evolution of credit markets and the proliferation of syndicated loans, documentation of large commercial loans and syndicated lines of credit requires more comprehensive credit and loan agreements. Today, many large syndicated loans are “useless,” and a promissory note is issued only if a lender requests it.
A promissory note demonstrates the obligation to repay a loan. Promissory notes can be issued as separate documents containing all the essential terms of the loan, or as abbreviated documents referring to an underlying loan or credit agreement, which contains the terms of the transaction. Separate notes are usually shorter than loan agreements and, although separate notes may contain some of the same provisions, they generally impose fewer obligations on the borrower. In transactions that use a loan or credit agreement, promissory notes usually refer to the loan agreement and require reading both documents to fully understand the terms.
However, because syndicated lines of credit and other large business loans can involve several scenarios, lenders use more comprehensive credit agreements, which are referenced in any promissory note or other supporting documents. There is often no legal requirement that a promise to pay be credited to a promissory note, nor is there any prohibition to include it in a loan or credit agreement. While promissory notes are sometimes thought of as negotiable instruments, this is not usually the case. Under Article 3 of the Uniform Commercial Code (UCC), a promissory note that qualifies as a negotiable instrument to be transferred may confer on an assignee greater rights under the promissory note than those of the assignor.
A transferee of a negotiable promissory note that is a timely holder under the UCC, takes the promissory note free and free of many claims and defenses that the manufacturer may have had against the original holder. However, to be negotiable, Article 3 requires that the promissory note include an unconditional promise of payment and all essential terms. If a promissory note is subject to or governed by the terms of another agreement (such as a credit agreement), it does not contain an unconditional promise or all essential terms. For this reason, most promissory notes on large commercial loans are non-negotiable, which means that the benefits that accompany negotiability are rarely applied.
Since most promissory notes no longer offer the benefits of negotiability or constitute a separate document containing all the essential terms, lenders should consider whether the notes are worth the additional issues they could create. For loans documented with credit agreements, the use of a promissory note could create inconsistency between documents. If certain terms are included in both documents, careful drafting will be required to ensure consistency not only between the two documents, but also between any supporting documents referring to those terms. In addition, any change to these terms during the life of the loan would require the amendment of both documents.
Any inconsistency or inaccurate reference between the original documents and any subsequent modification can create ambiguity and make application difficult. Lenders using notes with substantive terms and credit agreements must include a provision in the credit agreement stating that, in the event of any inconsistency between the documents, the terms of the credit agreement prevail. For lenders who require notes in addition to credit agreements, record-keeping policies should prevent notes from being lost or misplaced. If an enforcement action or other action is initiated in relation to a loan documented by a credit agreement that references a promissory note, a judge may require the lender to file the promissory note.
Finally, in syndicated lines of credit, where there are many lenders who frequently allocate their commitments and loans, allocations may require the issuance of new notes to assignees and the cancellation, reissuance, or modification of existing notes. For these reasons, in commercial loan transactions, lenders and their attorneys should consider the circumstances to determine if the utility of including promissory notes in closing documentation outweighs the potential burdens. The promissory note, a contract separate from the mortgage, is the document that creates the loan obligation. This document contains the borrower's promise to repay the borrowed amount.
If you sign a promissory note, you will be personally responsible for repaying the loan. When a loan changes hands, the promissory note is endorsed (passed on) to the new owner of the loan. In some cases, the note is endorsed blank, making it a bearer instrument under Article 3 of the Uniform Commercial Code. Whoever holds the note has the legal authority to execute it and is entitled to execute it.
For example, let's say you're not eligible for a mortgage loan with a good interest rate because your credit ratings are terrible. However, your spouse has excellent credit and easily qualifies for a loan. The lender agrees to lend to your spouse and does not include you as a borrower in the promissory note. But because both are on the deed to the house, the lender requires both of you to sign the mortgage.
A key benefit that a promissory note provides you, whether you are the borrower or the one providing the fund, is flexibility. A promissory note allows you to specify how payments will be made: in installments, at a future time, or on demand. For example, you can make interest-only payments with a balloon (a lump sum payment) at the end. You can fully repay the loan and make overdue payments on a monthly basis, or you can make equal quarterly or semi-annual overdue payments.
This flexibility allows you to specify the loan terms that best suit your needs or the needs of your business. . .
