Alternatives to a Loan Agreement

Borrowing may be documented with a promissory note rather than with a loan agree-ment. These types of promissory notes stand alone and are not used in conjunction with a loan agreement. They are sometimes called long form promissory notes because they are longer than those used to evidence loan agreements, and they contain many of the same types of provisions as those used in loan agreements.

A promissory note differs from a loan agreement in that only the borrower signs a promissory note. Thus, it is only the borrower (referred to as the maker or the issuer of the note) who undertakes any obligation under it: the promise to pay a fixed amount of money to the lender (referred to as the note holder) on demand or at definite times. Using a promissory note instead of a loan agreement typically benefits the note holder (the lender) more than the issuer (the borrower). First, a promissory note is a more liquid asset than a loan agreement. Because a promissory note may be a negotiable instrument, meaning that it can be freely transferred without the borrower’s permission, the lender can transfer ownership of the note fairly easily. In fact, in many jurisdictions, unless the promissory note provides otherwise, the lender can separately transfer its rights to individual payments under the note to one or more parties.3 This means that the lender could transfer half of the amounts outstanding to one party and the other half to a different party, or it could transfer the outstanding principal amount to one party and the inter-est component to another party.


A second advantage to the lender is that, in some jurisdictions, the rights and obligations provided under a promissory note are easier to enforce than those provided under a loan agreement. This is because promissory notes often qualify for more streamlined enforcement
proceedings that may provide more efficient remedies against defaulting borrowers.Countering these advantages for the lender are certain disadvantages for the borrower. One notable disadvantage is that, because the lender is not a party to the promissory note, it does not have any obligations it would otherwise have in a loan agreement (for example, obligations to mitigate damages, act reasonably, etc.). For this reason, where there is both a loan agreement and a promissory note, the borrower should ensure the promissory note refers to the loan agreement so that, in an enforcement action, the note can-not be deemed to stand alone without reference to the other loan agreement terms.


Laws governing promissory notes vary considerably from country to country. In some countries, promissory notes may not provide for principal amounts to be paid in installments (also called amortization); instead, in these jurisdictions, notes must specify that principal amounts are to be paid in a single installment (also called a bullet). In other cases, courts are entitled to disregard certain types of clauses when they are included in a promissory note. Even provisions covering interest payments can be problematic. Therefore, it is important to be familiar with local laws when using and structuring a promissory note.