Noteworthy: Should Lenders Use Promissory Notes?

September 2019

Traditionally, lenders used promissory notes to evidence (i.e., to legally document) their loans and borrowers’ obligations to repay them. However, with the evolution of credit markets and the proliferation of syndicated loans, the documentation of large commercial loans and syndicated credit facilities requires more comprehensive credit and loan agreements. Today, many large syndicated loans are “noteless,” with a promissory note being issued only if a lender requests one. 

A promissory note evidences an obligation to repay a loan. Promissory notes can be issued as standalone documents that contain all essential loan terms, or as short-form documents that refer to an underlying loan or credit agreement, which contains the terms of the transaction. Standalone promissory notes are typically shorter than loan agreements, and although standalone promissory notes may contain some of the same provisions, they typically impose fewer obligations on the borrower. In transactions using a loan or credit agreement, promissory notes typically reference the loan agreement, requiring a reading of both documents to fully understand the terms.

However, because syndicated credit facilities and other large commercial loans can involve various scenarios, lenders utilize more comprehensive credit agreements, which would be referred to by any promissory notes or other ancillary documents. Often there is no legal requirement that a promise to pay be evidenced in a promissory note, nor any prohibition from including it in a loan or credit agreement.

Although promissory notes are sometimes thought to be negotiable instruments, this typically is not the case. Under Article 3 of the Uniform Commercial Code (UCC), a promissory note qualifying as a negotiable instrument that is transferred may convey greater rights to a transferee under the promissory note than that of the transferor. A transferee of a negotiable promissory note who is a holder in due course under the UCC, takes the promissory note free and clear of many claims and defenses that the maker may have had against the original holder. However, to be negotiable, Article 3 requires that the promissory note include an unconditional promise to pay and all essential terms. If a promissory note is subject to or governed by the terms of another agreement (such as a credit agreement), it does not contain an unconditional promise or all essential terms. For this reason, most promissory notes in large commercial loans are not negotiable, which means that the benefits accompanying negotiability seldom apply.

Given that most promissory notes no longer provide the benefits of negotiability or constitute one standalone document containing all essential terms, lenders should consider whether promissory notes are worth the additional issues they might create. For loans documented with credit agreements, using a promissory note could create inconsistency between the documents. If certain terms are included in both documents, careful drafting will be required to ensure consistency not only among the two documents, but also among any ancillary documents making reference to such terms. In addition, any changes to such terms during the life of the loan would require amendments to both documents. Any inconsistencies or inaccurate references among the original documents and any subsequent amendments can create ambiguity and hinder enforcement. Lenders using promissory notes with substantive terms and credit agreements should include a provision in the credit agreement stating that in the event of any inconsistencies between the documents, the terms of the credit agreement control.     

For lenders requiring promissory notes in addition to credit agreements, record keeping policies need to prevent promissory notes from being lost or misplaced. If an enforcement or other action is commenced in connection with a loan documented by a credit agreement that references a promissory note, a judge may require the lender to produce the promissory note. 

Finally, in syndicated credit facilities, where there are many lenders that frequently assign their commitments and loans, assignments may require new notes to be issued to assignees, and existing promissory notes to be canceled, reissued, or amended. This can be administratively burdensome.   

For these reasons, in commercial lending transactions, lenders and their counsel should consider the circumstances to determine whether the utility of including promissory notes in the closing documentation outweighs the potential burdens.