What is a promissory note, how does it work and when can it break your budget?

What is a promissory note and why is it so strict

If you ask what a bill of exchange is, the answer is seemingly simple: a bill of exchange is a security that unconditionally commits someone to pay a certain amount. It is the word “unconditionally” that is key. A promissory note is not a traditional contract where the question is who has breached what and why. In the case of a promissory note, the courts usually only address whether it is formally correct.

The bill of exchange originated as a tool for quick trading and securing debts. However, in today’s practice it is also very often used between non-business people – for example, to secure a loan, rent or a debt between friends. For a creditor, a promissory note is extremely powerful. For the debtor, it can be extremely dangerous because the defences against it are significantly limited.

What the law on bills of exchange and cheques says

Bills of exchange are not governed by the Civil Code, but by a special law, the Bills of Exchange and Cheques Act. This law places particular emphasis on the form and security of the creditor. If a bill of exchange meets the legal requirements, it has a very strong position – often stronger than any loan agreement.

The Bills of Exchange and Cheques Act also limits the objections that a debtor can raise. In other words, even if you feel the debt is not fair, with a promissory note, that is often not enough. That’s why it’s so important to understand what you’re signing.

Difference between promissory note and foreign promissory note

In practice, you will encounter two basic types. The first is the promissory note. In a promissory note, the drawer of the note directly promises to pay a certain amount to the beneficiary. Typically, it is signed by the borrower who agrees to pay the lender.

The second type is a promissory note. In a promissory note, the drawer of the note does not promise to pay himself, but commands a third party to pay. This third party becomes the debtor only when the bill is accepted. It is the acceptance of the bill of exchange that is the key point at which the ‘addressed’ party becomes the actual debtor.

The difference between a promissory note and a foreign promissory note determines who will actually pay. In the case of a promissory note, it is the signatory who undertakes to pay. However, in the case of a promissory note, it often happens that a person signs the document thinking that he is only confirming the transaction, unaware that by accepting the note he becomes a full-fledged debtor. In practice, it is not uncommon for someone to pay someone else’s debt simply because they did not understand what type of promissory note they were signing.

Essentials of a promissory note or when a promissory note is valid

A bill of exchange is an extremely formal document. The particulars of a promissory note are not only recommended, but mandatory. If any of them are missing, the promissory note may be invalid. At the same time, however, if the particulars are fulfilled, the bill of exchange has very strong effects.

The essential elements of a bill of exchange include, among other things, the indication that it is a bill of exchange, a clear obligation to pay, the amount, the name of the person to be paid, the date and place of issue and the signature of the drawer. The signature is the moment when you take on a huge obligation – often more than you realise. In addition, the payer (the drawer) must be named on the foreign bill of exchange. The maturity of the bill of exchange is either explicitly stated or governed by statutory rules.

The drawer and the drawee: who actually pays

The drawer of a bill of exchange is the person who draws and signs the bill. It is by signing it that he or she takes responsibility for its performance. In most cases, the drawer of the bill of exchange is also the drawee , i.e. the person who must pay the stated amount on the due date. This is typically the case with promissory notes, where the drawer explicitly promises to pay the money.

However, for other types of promissory notes, the roles are split and this is where the biggest problems arise. For example, in a foreign bill of exchange, the drawer of the bill does not designate himself as the payer but commands someone else to pay. Once that person accepts the note, he or she becomes the promissory note debtor with all the consequences – even if he or she had nothing personally to gain from the loan or trade.

A very common and dangerous example is the signing of a promissory note by a company’s managing director. Often the managing director thinks that he or she is “just acting for the company” and does not realise that if he or she does not sign the bill in the right way, he or she may become a personal debtor. In such a case, the creditor does not recover the debt from the company, but directly from the managing director – and from his personal assets, not from the company’s assets.

This is why it is not only the person named in the text that is crucial for promissory notes, but also how the note is signed. One misspelled sentence or a missing designation of function can mean that a completely different person than the one who originally intended it will be liable for the debt.

Acceptance of a promissory note: The moment that changes everything

Acceptance of a promissory note is the moment when a person who was previously just listed on paper becomes the actual debtor of the note. It is the legal act by which the person written on the bill of exchange expressly confirms that he or she will pay the bill. Most often, acceptance of a promissory note is made by simply signing the face of the note, sometimes accompanied by the words ‘I accept’ or ‘I accept’. It is this unobtrusive signature that has major legal implications.

In the case of a foreign bill of exchange, acceptance is absolutely crucial. Acceptance makes the payer the principal (direct) debtor. Without acceptance, it is usually enforced primarily against other persons obliged by the bill (e.g. the drawer), but the situation may vary according to the type of bill and the clauses. An accepted bill of exchange creates a direct, independent and very strong obligation to pay the amount stated, regardless of the original reason for the bill.

In practice, people often underestimate the acceptance of a promissory note. They accept a bill of exchange merely as a formality to make the transaction go through, without realising that they are thereby taking on a liability comparable to a personal debt. If the promissory note is not paid on the due date, the creditor can seek payment directly from the drawee of the promissory note by very quick legal action.

The acceptance phase is one of the last moments when the future debtor has a realistic opportunity to act. It is possible to refuse to accept the promissory note, to request a change in its content, to limit the scope of the obligation or to clarify the conditions under which the note is to be drawn. But once the promissory note is accepted and signed, the room for negotiation shrinks considerably – and in some cases disappears altogether.

A promissory note without protest: A small sentence, a big problem

The formulation “promissory note without protest” is subtle, but from a legal point of view it significantly strengthens the position of the creditor. A protest is a formal step that may be necessary to prevent the creditor from losing certain recourse rights against others on the note. A ‘no protest’ clause removes this obligation and makes it easier for the creditor to exercise its rights. The protest is usually made through a notary or a court and serves as proof that the debtor has not fulfilled his obligation. In the case of an ordinary promissory note, the creditor must protest or risk losing some of his rights.

However, if the bill of exchange states that it is issued “without protest”, this obligation is waived. The creditor no longer needs to provide any formal proof of non-payment and can proceed straight to the next steps. This means that he can almost immediately file a lawsuit or an application for a bill of exchange order after the due date has passed.

For the debtor, a promissory note without protest has very unpleasant consequences. He loses time that he could otherwise have used to resolve the situation, negotiate with the creditor or prepare a defence. The whole process is significantly accelerated and the debtor often only becomes aware of the problem for the first time when he receives a court order or a demand for payment with a very short deadline.

This is why a promissory note without protest is significantly riskier than a regular promissory note. A single short sentence on the document can mean the difference between a few weeks to resolve and almost immediate court or enforcement proceedings. If you encounter “no protest” wording, extra caution and ideally legal advice is in order before signing the promissory note.

Blank promissory note: The riskiest type of promissory note

A blank promissory note, or bianco, is a promissory note that is not completely filled out when signed. Typically, the amount or due date is missing. The drawer of the bill gives the other party the right to fill in these details later. The blank bill of exchange is the source of most disputes.

People often believe that the amount will be completed “fairly”. However, if there is a dispute, the court will usually rely on the completed bill of exchange, not on oral agreements. Thus, a blank promissory note can mean a commitment to a much higher amount than you expected.

Summary

A promissory note is a highly formal security that unconditionally commits someone to pay a certain amount, and because of its strictness under the Bills of Exchange and Check Act, it often has stronger effects than a regular loan agreement. There is the promissory note, where the drawer of the promissory note is directly obliged to pay, and the promissory note of a stranger, where the person who accepts the note becomes the debtor – often without realising that he or she is taking on a personal debt. A key role is played by the particulars of the bill of exchange, because if they are fulfilled, the courts do not usually examine the circumstances of the debt, but only the formal correctness of the document. Particularly risky are situations where the promissory note is signed incorrectly (e.g. by an executive without a clear definition of the role), where the note is accepted “as a formality”, or where the note is issued without protest, which significantly speeds up the creditor’s journey to court or enforcement. The greatest danger is posed by a blank promissory note where key details are added after the fact and the courts rely on the final form of the note rather than the original oral agreements. A promissory note can thus be an effective tool for the creditor, but for the debtor it very easily represents a liability that can seriously undermine his personal and financial stability.