Promissory note

A promissory note is a written promise to pay money. Nothing more complicated than that.

One person signs it. That person is the maker. The note says the maker will pay a stated sum to a stated person, or to whoever that person directs, or to whoever is holding the paper.

The promise has to be unconditional. If it depends on something happening first, it is not a promissory note.

The sum has to be certain, and it has to be money. A promise to hand over goods does not qualify.

One exclusion is written into the definition. A bank note and a currency note are not promissory notes, even though both are promises to pay.

The note is one of three instruments defined by the Negotiable Instruments Act, 1881. The other two are the bill of exchange and the cheque. All three are negotiable, which means the right to be paid can be passed on to someone else.

An Investment Adviser meets these in Chapter 18 because clients hold them, lend against them and are sometimes asked to sign them.

Section 4 of the Act, which is the definition worth knowing. A promissory note is an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer of the instrument.

Pull that apart, because every clause excludes something:

Its two siblings, from the same Act. Section 5 defines a bill of exchange as an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer. Section 6 defines a cheque as a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand, including the electronic image of a truncated cheque and a cheque in electronic form.

The structural difference is in one word. A promissory note is an undertaking — the maker promises to pay. A bill of exchange is an order — the maker directs somebody else to pay. That is why a note has two parties and a bill has three.

Section 13 and negotiability. A negotiable instrument means a promissory note, bill of exchange or cheque payable either to order or to bearer.

• Payable to order where it is expressed to be so payable, or is expressed to be payable to a particular person and does not contain words prohibiting transfer or indicating an intention that it shall not be transferable.
• Payable to bearer where it is expressed to be so payable, or where the only or last endorsement is an endorsement in blank.
• Where a note is expressed to be payable to the order of a specified person, and not to him or his order, it is nevertheless payable to him or his order at his option.
• A note may be made payable to two or more payees jointly, or in the alternative to one of two, or one or some of several payees.

Purpose and scope of the Act. The Negotiable Instruments Act, 1881, defines and amends the law relating to promissory notes, bills of exchange and cheques. Its purpose was to regulate transactions relating to day-to-day commerce and the means of making payment. The customs followed earlier relating to an instrument in an oriental language, the Hundi, are not affected by the Act. The Act also deals in detail with the capacity of the parties to notes, bills and cheques, and with the liability of the parties concerned.

Mr Saraf lends Rs 5,00,000 to his cousin Mr Jalan for two years. He wants something better than a WhatsApp message.

Mr Jalan signs a note: I, Ramesh Jalan, promise to pay Anil Saraf or order the sum of Rs 5,00,000 on 30 September 2027. He signs it and dates it.

Test it against Section 4:

It is a valid promissory note, and because it is payable to order it is a negotiable instrument under Section 13. So Mr Saraf can endorse it over to someone else, who then has the right to collect the Rs 5,00,000.

Now break it three ways and watch it stop being a promissory note.

1. I promise to pay Rs 5,00,000 if my flat in Thane sells by March. The undertaking is now conditional. Not a promissory note.
2. I promise to pay Rs 5,00,000 or 40 grams of gold, at my choice. The sum is no longer a certain sum of money only. Not a promissory note.
3. I direct my tenant to pay Rs 5,00,000 to Anil Saraf. That is an order to a third party, not an undertaking — which makes it a bill of exchange under Section 5, not a note.

And a fourth, which changes only the transferability. If Mr Jalan had written pay Anil Saraf only, with words prohibiting transfer, the instrument would still be a valid promissory note but would not be negotiable under Section 13. Mr Saraf could collect the Rs 5,00,000 himself and could not pass the claim on.

That last distinction is the one an adviser is most likely to need. A client asked to accept a note instead of cash should know whether he can sell it on if he needs the money early.

Chapter 18 (Key Regulations), section 18.8.4 (Negotiable Instruments Act, 1881), which quotes Sections 4, 5, 6 and 13 in sequence. The three definitions are examined against each other, so the question usually supplies a described instrument and asks which of the three it is. The reliable discriminator is undertaking versus order: a note is an undertaking by the maker to pay, a bill is an order directing someone else to pay, and a cheque is a bill drawn on a specified banker payable on demand. Expect a second question on payable to order versus payable to bearer.

• A promissory note is an undertaking; a bill of exchange is an order. Two parties against three. This one distinction answers most questions from this section.
• A bank note and a currency note are expressly excluded by Section 4, even though both promise to pay.
• Unconditional means unconditional. Any if attached to the promise takes the instrument outside Section 4.
• A certain sum of money only. Goods, gold or an amount to be determined later will not do.
• Not every promissory note is negotiable. Section 13 requires it to be payable to order or to bearer; words prohibiting transfer keep it valid but non-negotiable.
• Payable to the order of a specified person, and not to him or his order, is still payable to him or his order at his option. The Act fixes this drafting slip for you.
• A cheque is a species of bill of exchange, not of promissory note — drawn on a specified banker and payable on demand.
• Hundi customs are not affected by the Act. An option saying the Act overrode them is wrong.