What is a promissory note?

A promissory note is a signed written promise by one party — the maker — to pay a sum of money to another party — the payee — either on demand or at a fixed or determinable future time. A promissory note is used across countless commercial situations — friends-and-family loans, founder loans to a corporation, shareholder loans, intercompany loans within a corporate group, vendor financing, deferred purchase price in an asset purchase agreement or share purchase agreement, settlement payments, and bridge financing. A promissory note is generally simpler than a full loan agreement and is often used where the parties want a clean, enforceable record of a debt without the procedural complexity of a long-form credit facility.

Why you should consider a promissory note

Documenting a loan or advance of funds. A promissory note creates a clear written record of a loan, the amount advanced, the interest rate, the repayment schedule, and the date of repayment. Verbal or informal loan arrangements leave both parties exposed to disputes about whether the funds were a loan, a gift, or a capital contribution.

Supporting friends, family, and founder lending. A promissory note is commonly used to document loans between friends, family, and business founders. Properly documenting these advances through a promissory note protects against later disputes about the nature of the advance.

Creating a negotiable, enforceable instrument. A promissory note that meets the requirements of the Bills of Exchange Act is a negotiable instrument that can be transferred to a third party and that benefits from streamlined enforcement procedures. A promissory note in proper form can be a more efficient enforcement tool than a contractual debt embedded in a longer agreement.

Relevant laws and regulations

Bills of Exchange Act, RSC 1985, c B-4. Canada’s federal legislation governing bills of exchange, cheques, and promissory notes, which sets out the essential requirements of a valid promissory note and the rules governing transfer, presentment, dishonour, and protest.

Income Tax Act, RSC 1985, c 1 (5th Supp). Canada’s federal tax legislation, which can affect the treatment of a promissory note, including rules on shareholder loans, imputed interest on non-arm’s length loans, and the deductibility of interest expense for the maker of a promissory note.

Bankruptcy and Insolvency Act, RSC 1985, c B-3. Canada’s federal insolvency legislation, which can affect the enforceability and priority of a promissory note where the maker becomes insolvent and which governs how holders of a promissory note participate in insolvency proceedings.

Common legal issues

Essential elements of a valid promissory note. Under the Bills of Exchange Act, a promissory note must be an unconditional written promise to pay a sum certain in money, signed by the maker, payable on demand or at a fixed or determinable future time, and made to or to the order of a specified person or to bearer. A promissory note that fails any of these requirements may not qualify as a negotiable instrument under the Bills of Exchange Act and may need to be enforced as an ordinary contractual debt instead. Common drafting errors that undermine validity include conditional payment language, vague principal amounts, and missing payee identification.

Interest rates and the criminal interest rate. A promissory note can charge interest, and the rate is generally a matter of contract. However, section 347 of the Criminal Code prohibits effective annual rates of interest above the criminal interest rate, and certain provincial consumer protection regimes regulate interest in retail credit transactions. A promissory note that charges interest above the legal limits — including through default rates, fees, or compounding — can be unenforceable in part or in whole.

Security, guarantees, and supporting documents. A promissory note can be unsecured or supported by security and guarantees. Where a promissory note is secured by collateral, a separate security agreement and registration under provincial personal property security legislation are generally required.

Default, demand, and enforcement. A promissory note generally defines events of default — including failure to pay on demand or at maturity, insolvency of the maker, and breach of related agreements — and the consequences of default. A promissory note that is silent or vague on default and acceleration can leave the payee with limited remedies and can complicate enforcement when the maker fails to pay.

Frequently asked questions

What is the difference between a promissory note and a loan agreement? A promissory note is a relatively short instrument that records a promise to pay, while a loan agreement is a longer contract that sets out the broader terms of the lending relationship — including covenants, conditions precedent, representations, warranties, and detailed default provisions. A promissory note is commonly used either on its own for simple loans or alongside a loan agreement for more complex credit facilities.

Can a promissory note charge interest? A promissory note can charge interest at a rate agreed by the parties, subject to the criminal interest rate under section 347 of the Criminal Code and any applicable consumer protection legislation. A promissory note that does not specify an interest rate is generally treated as a non-interest-bearing note unless interest is implied by the surrounding circumstances or required by law.

Is a promissory note transferable? A promissory note that meets the requirements of the Bills of Exchange Act and is payable to order or to bearer is generally transferable by endorsement and delivery. A promissory note that is marked “non-negotiable” or otherwise drafted to restrict transfer can limit or eliminate the right to transfer the note to a third party.

What happens if the maker of a promissory note does not pay? If the maker of a promissory note fails to pay, the payee can generally demand payment, accelerate the obligation if the note allows, and pursue enforcement through the courts within the applicable limitation period. Where the promissory note is secured or guaranteed, the payee can also enforce against the collateral or pursue the guarantor in accordance with the supporting documents.