This article has been written by Nishish Mishra, pursuing a Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.
Table of Contents
Introduction
There are countless situations in life where you seek to borrow money to keep your life moving without conceding on money. However, when it comes to lending, this process can be difficult at times, especially if you are unfamiliar with the documents you have to sign and have. It is very important to use the right type of document when borrowing money. Whether you are a creditor or a debtor it is important to consider what type of document you will use to set the terms of your loan.
There are two main types of contracts: A Promissory Note/ Note of Pledge and a Loan Agreement. While they may seem to do the same job, there is a big difference between them that you should consider before choosing one. You can reduce the risk of default by having written documents that set out the terms of the loan. This can do the following things:
- Make the parties agree on something positive and constructive.
- Provide ratification of the agreement.
- Provide a legal solution if the other party does not fulfill its obligations.
Having one of these legal documents ensures that both the lender and the borrower are aware of their rights and legal obligations. Also, it helps to avoid conflicts and misunderstandings. When writing a promissory note or loan agreement, you should make sure that the official tool accurately and precisely reflects the wishes of both parties.
So here, through this article, I will try to guide you on how to choose one of the two by knowing the differences between them in detail so that you can choose the best option for yourself.
Promissory note/ Note of promise
A Promissory Note/ note of promise is issued under Section 4 of the Negotiable Instruments Act, 1881. In terms of Section 4 of the Negotiable Instruments Act, 1881, a “Promissory Note” is a written instrument (non-bank or cash) that contains unconditional commitment signed by the manufacturer, paying only a certain amount, or to order from someone, or to the bearer of the instrument.
The promise can either be secured or unsecured. If there is a secured note, the borrower will be required to provide collateral such as goods, properties, services, etc., in case they fail to repay the loan. The amount of the loan offered should be more than or equal to the amount of the loan. And in the case of an unsecured Note of Promise, no guarantee needs to be given.
Promise Notes issued in one Indian country may be displayed in another form as long as the note contains a valid stamp. No additional stamp duty is required. It must always be handwritten and must include all mandatory items such as the payee name and drawer’s name, the loan/repayment amount, the full terms of the agreement, and the full amount of the loan, among other things. The note should clearly state only the promise to make the payment and not any other miscellaneous conditions.
Upon issuance, the Promise Note must be stamped in accordance with the provisions of the Indian Stamp Act. It is common practice to use a stamp of income on a note signed by a pledge and/or signed by a borrower. It can also be removed from the Stamp paper in case the revenue stamps are not available. All Promise Notes are only valid for a period of 3 years from the date of issue, after which they will not be valid. It should also be noted that there is no maximum limit on the amount of money that can be borrowed or lent.
The issuer/lender is usually the one who will hold the Promissory Note. Once the loan amount has been repaid or paid off in full, the Promissory Note must be canceled and marked as “Full Payment”, after which it can be returned to the lender/borrower. While the signing of witnesses is not a mandatory requirement, it is advisable to have a note signed by an independent witness in the proceedings.
Now that we know what a promise is, let’s try and understand the situations in which it is best to use a promise.
When to use the Promissory Note?
The greater the use of the promise notes the lesser is the amount of money. In addition, the money is lent to someone very close to you. For example, your cousin or relative. This is because you have a trusting relationship with the other party, and you both do not want to be involved in a legal agreement as you know that whatever happens, you will eventually get your money back without needing any legal proceeding.
Another great reason you can use this is that it is a very convenient way to get back the amount where you both know it is not very legal and there is a good chance that the date when you have to repay the money is not a deadline and can be changed, as the promissory note does not include a legal agreement. Both parties can change dates or the mode of installment. A note of promise is a good idea if you do not want to write or sign a loan agreement, but still want proof of the amount we owe. It is important to ensure that the sections of your promissory note are not being overused.
Are you trying to figure out what to include and what not to include in a promise note? Don’t worry, in the next section I have written down a few key points of a promissory note for your consideration.
Important parts of a Promissory Note
Major components within the promissory note are stated as under:
- Loan amount granted to the borrower.
- Maturity date.
- Interest rate (if any).
- Late payment.
However, the format mentioned above can vary from note to note and depends on the groups in particular. If the parties aim to have a common note and the money involved is also not significant.
Loan agreement
A loan agreement is a very complex document that can protect both parties involved in a loan or transaction. Before lending to anyone, any money or providing services free of charge, it is important to know if you need to have a loan agreement to be protected. You would never want to borrow any money, goods, or services without having a loan agreement to ensure that you will be repaid or that you can take legal action to get your money back. The purpose of a loan agreement is to specify the details of the loan and when and how the borrower must repay.
In many cases, the lender/issuer creates a loan agreement, which means that the burden of entering into all the terms of the agreement falls on the lender/issuer. It should contain specific words that specify the details of the offer and what is expected to be returned. Once done, it is actually becoming a promise of payment from the lender to the borrower. The loan agreement not only provides details of the loan, but also serves as proof that the money, goods, or services advanced were not a gift to the borrower.
If you are trying to decide if you need a loan agreement, it is always best to be on the safer side and write one. If it is a large sum of money, as agreed upon by both parties, then take further steps to ensure that the payment happens on time. The loan agreement is designed to protect you so if in doubt, make a loan agreement and make sure you are safe no matter what.
Let us now consider circumstances in which using a loan may seem to be the best way.
When to apply for a loan agreement?
Loan agreements are very helpful when it comes to borrowing large sums of money. It is also recommended that you use it if you want to make the agreement legal, and the other party involved cannot be trusted personally. The advantage of using a loan agreement over a promise here is that you can sit back and relax, and you don’t have to worry about getting your money back. The loan agreement guarantees compliance with the terms and conditions, if necessary, providing both parties with a guarantee that the lender will repay the loan and the borrower will repay the loan. As with anything that goes down, you will always get your money back in any way.
An example would be if you want to lend/advance or facilitate money to a relative, and the amount is very large, for example, say, you want to buy a car or a house, in this case, the amount of money involved is very large, and you need to make sure that your money is safe. Therefore, adhering to a loan agreement is very obvious here, as choosing a promise note here can be very risky.
Does the above reading make you wonder about the terms included in the loan agreement? I got you covered below.
Major parts of the loan agreement
The loan agreement has four main sections. While each agreement is different depending on the circumstances of the case, the general four-section rule is still followed. Below are those four parts.
- Definitions and definitions
- Financial / Commercial Information
- Transaction Details
- Types of Loan Agreements
Conclusion
We have learned that both loan agreements and pledge notes are binding – and binding – documents setting out repayment terms. However, a loan agreement usually contains clear and concise terms, with major obligations and limitations imposed on the borrower. It also often includes security features (e.g., placing a house as collateral) and the promise is usually not secure. As a general rule, if a small amount of money is involved and there is a great deal of trust between the lender and the borrower (or debtor), a note of guarantee should suffice. However, if there is a large debt involved and both parties are not overly familiar, a loan agreement is highly recommended. Lastly, whichever method you choose, remember that you should always make sure that the official form used is correct and reflects the interests of both parties.
References
- https://legalvision.com.au/promissory-note-and-loan-agreement/.
- https://lawpath.com.au/blog/difference-promissory-note-loan-agreement
- https://www.rocketlawyer.com/gb/en/quick-guides/loan-agreements-and-promissory-notes.
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