Promissory Notes - a Brief Overview
Ancient Origins, Modern Importance
Promissory notes are believed to have originated in ancient China, and then made their way into European history, before ultimately becoming an important part of modern business. In ancient times money was made of precious metal, and any large transfer of funds over a distance was a heavy proposition, so promissory notes evolved as a lighter alternative. Now it is common to use promissory notes in many different business transactions, and for loans between private individuals. The Canadian Bills of Exchange Act (R.S.C., 1985, c. B-4) creates a statutory definition in section 176(1) for promissory notes in Canada:
“an unconditional promise in writing made by one person to another person, signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money to, or to the order of, a specified person or to bearer.”
What are the Benefits of Promissory Notes?
The main benefit of a promissory note is that it clearly documents an obligation to pay money, and creates a strong cause of action in the event that the issuer defaults upon the note. The signed promissory note is effective from the time it is made, and is an independent obligation of the issuer. If the note is drafted properly, the holder of the note can sue upon it without having to prove much beyond the fact that the defendant issued the note, and then defaulted upon it.
Strategically, having a signed promissory note can be invaluable to a creditor seeking to collect upon a debt. Collections work is pragmatic, and no creditor wants to spend more money enforcing a debt than the debt is actually worth. Litigation is expensive, and it takes a significant amount of time to obtain a judgement. In order to provide a more efficient method of obtaining judgment, the British Columbia Supreme Court Civil Rules contain a process called a summary trial. A summary trial is available in cases where a judge is able to decide the issue without having to hear live testimony and weigh the credibility of the parties. A signed promissory note can help a creditor to qualify for the summary trial process, and as a result obtain a more rapid and cost effective judgment against the debtor.
What are the Disadvantages of a Promissory Notes
Promissory Notes Disadvantage #1 - A Sum Certain in Money
In order to be a promissory note, the document must make it clear that the issuer of the note is unconditionally promising to pay a specific amount of money. This makes a promissory note distinguishable from a revolving line of credit. The note must make it clear how much is owed by the issuer of the note. If the amount is not clear, then you have no promissory note, and consequently a big problem.
Promissory Notes Disadvantage #2 - Interest
If the note contains interest, it must be clear how interest is calculated. This ties in to the requirement that the note be for a sum certain in money. The interest must be capable of being objectively calculated, and this requires that the rate of interest be stated, along with the formula for how interest is calculated – e.g. simple interest, or interest compounded monthly.
Promissory Notes Disadvantage #3 - Notice of Default or Demand for Payment
Notes need to make it clear when a default has occurred. Many notes with regular payments contain a provision that the holder of the note must give notice of default to the issuer of the note, and the issuer must fail to remedy the default within a certain period of time, before the issuer can accelerate the debt and collect. If you are the one signing the promissory note, you may want a provision that gives you time to remedy a default without the holder of the note taking collection actions. On the other hand, if you are the holder of the note, you need to make sure that you give notice of a default correctly, and wait the requisite amount of time before taking collection actions.
For promissory notes that are payable on demand, you will also likely want to include in the note the amount of time that the issuer has to pay the note, after demand has been given. Under the common law, the issuer had a reasonable amount of time to satisfy the demand, and this had to be assessed taking into consideration the amount of the note. You would be wise to include a specific amount of time in order to avoid this issue, and make it totally clear how much time the issuer has to satisfy the demand.
For both defaults on installment notes, or demands for repayment on demand notes, the note should specify whether the notice must be given in writing, and whether it needs to be given at a particular place. In order to give effective notice, the holder of the note will need to comply with these requirements, or else the notice may be ineffective and therefore not trigger the issuer’s obligations.
Promissory Notes Disadvantage #4 - Limitation Periods
Promissory notes can be either due on demand, or else contain specific dates on which payments must be made. For both types of notes, if the issuer defaults, you must bring a civil action to enforce the note within the applicable limitation period. The Limitation Act [SBC 2012] c.13 creates a general two year limitation period to commence a civil action. This limitation period runs from the date that the claim is discovered. For a note with regular payments, a claim would usually be discovered when the issuer of the note defaults upon a payment and fails to remedy the default within any time specified in the note.
For demand notes however, the situation is potentially much different. A note payable on demand can be demanded by the holder of the note at any time. Under the common law, demand notes were considered to be due and payable when the note was issued, and the limitation period ran from that date. Fortunately, the Limitation Act contains section 14, which provides that for claims upon a demand obligation, the claim is discovered on the first day that there is a failure to perform the obligation after a demand for performance has been made. This protects the holder of a demand note from their claim becoming statute barred before they have even issued a demand for performance. This only protects the holders of demand notes in British Columbia, and other jurisdictions might have less forgiving limitation periods.
Whether your note is payable in installments, or due on demand, it is vital to commence your enforcement proceedings quickly after there is a default. Failing to do so might result in your claim expiring, and then you are left unable to collect upon the amount in court.
Promissory Notes Disadvantage #5 - Acceleration on Default
When a note contains payment in installments, and a payment is missed, this traditionally only allows the holder of the note to sue for the missed payment. The holder of the note could not sue for the full amount of the note unless there is a provision allowing the holder to accelerate the debt. Acceleration is important, because if the issuer of the note starts missing payments, you want to be able to claim the whole amount owing immediately, and not have to commence a separate lawsuit for each missed payment as the payments are missed. Promissory notes are subject to the legal rule of contra proferentem, meaning that courts will strictly interpret any ambiguity in the note against the party who drafted it, resolving any doubt about the meaning of a term in favor of the other party. It is important that the provision is drafted clearly, and gives the holder of the note the unambiguous right to claim the entire outstanding amount as immediately due and owing if the issuer of the note defaults upon a single payment.
From a practical point of view, you might choose not to accelerate the note, but the threat of doing so is a powerful bargaining chip to keep the issuer of the note on track with their payments.
Should I Hire a Lawyer to draft a Promissory Note?
Our office routinely sees promissory notes that were drafted by the parties themselves without the benefit of legal assistance. These notes can range from relatively well drafted notes that are still enforceable despite their flaws, to totally useless pieces of paper that provide nothing more than a false sense of security. Even worse, we see clients who loaned money or made an agreement verbally and did not get a signed promissory note at all, which makes it potentially much harder to collect the amount owed.
For a lawyer, drafting an enforceable promissory note is relatively simple, and can be done for the client affordably. The lawyer will also meet with you to review your specific circumstances, and can advise you about any particular pitfalls in your situation, or about additional steps that you can take to protect yourself. In many cases, if you are loaning money and the debtor has assets, you might also want to obtain security over those assets so that you have collateral in the event that the debtor defaults. When the small cost of having a lawyer draft the note is compared with the huge hassle you can face in the event of a default, it is clear that if you are lending any significant amount of money, you’d be wise to have a lawyer prepare a promissory note.