Simply Finance is a series of newsletters that we hope can contribute to increased understanding of financing law and to demystify financing documents. Our aim is to explain concepts, terms and expressions in a simple way so that anyone can understand them. This time we address issues related to promissory notes.
What is it?
A promissory note is a debt instrument that contains a promise made by a debtor to pay a creditor.
Certain requirements must be satisfied for a debt instrument to be considered a promissory note under Norwegian law, i.e.: (i) being made in writing and signed by the debtor, (ii) including an unconditional obligation for the debtor to pay when due, and (iii) the obligation must be a specified cash payment obligation.
In addition, there is an important distinction between simple promissory notes (Nw. enkle gjeldsbrev) and negotiable promissory notes (Nw. omsetningsgjeldsbrev). The latter comprise notes that either (a) is addressed to the holder at any time (no specific creditor is mentioned), (b) is addressed to a specific creditor or any subsequent transferee, (c) establishes a security interest over the debtor’s real property or ship, or (d) specifically is named a negotiable promissory note.
Why is it used?
Financing documents can be extensive and complicated with finance agreement(s) and ancillary documents consisting of several hundred pages. The reason is partially that financing documentation has been influenced by London documentation such as the Loan Market Association (LMA), but also that the agreements often have to be tailored to the specific transaction. Term sheets and finance agreements are thoroughly negotiated with assistance from lawyers on both sides and the financing process can take several weeks.
However, not all financings are complex and require full-blown LMA documentation. For less complex or non-syndicated financing transactions (such as real property financing or loans to small and medium sized companies), standardised promissory notes are often used by banks and other financial institutions to effectively reduce the resources and time needed to document the financing transaction. It is an effective tool for the financing banks and often reduces costs for the parties involved.
A promissory note will often give the lender a direct enforcement right. By including an acceptance by the debtor that the lender has the right to enforce directly through the Norwegian enforcement authority, the lender does not have to establish separate legal basis for enforcement, such as initiating civil action to obtain a binding and enforceable court order. Note that the debtor’s signature on the promissory note must be confirmed by two witnesses for such direct enforcement to be possible, unless the promissory note is issued to a financial institution.
How is it used?
If a promissory note is used, Norwegian banks often document the specific terms of a financing in an offer letter, which forms part of the loan agreement with the borrower when accepted by the borrower. A promissory note, including the bank’s general terms and conditions, will typically be attached to the offer letter, and the borrower will be requested to confirm acceptance by signing and returning the offer letter and the promissory note to the bank. The offer letter is often structured so that the specific terms set out therein prevail in case of conflict with the promissory note’s general terms and conditions.
The promissory note will typically contain all other relevant terms relating to the loan, inter alia, loan amount, interest rate, issue date, maturity date (specification of repayment date(s) or on-demand payment), security interests, events of default and enforcement provisions. As such, the offer letter and promissory note serve the same purpose as the term sheet and financing agreement typically used in complex and/or syndicated financing transactions.
Why should a lender pay attention?
Although standardised promissory notes are regularly used by Norwegian financial institutions, it is important to ensure that conditions for the loan document to be considered a promissory are satisfied. The debtor’s payment obligation must be unconditional. Further, the amount owed must be a specified amount of money. For example, it is not sufficient for a loan agreement to be called a “negotiable promissory note” if the underlying claim is specified to be paid in kind.
It can sometimes be unclear whether the obligation of the debtor is in fact unconditional. If the loan is made subject to terms and conditions of a separate loan agreement not attached to the relevant loan document, the lender may have to obtain a binding court order of the claim before it may be enforced.
What does it mean for the borrower?
A negotiable promissory note may entail a risk for the borrower of losing its right to object against the note’s underlying claim upon a transfer to a third-party creditor acting in good faith. Generally, this does not affect the debtor’s right in respect of interest and fees due and payable prior to the transfer. Further, the debtor may object due to improper pressure, duress, influence, extortion or misrepresentation in connection with the underlying claim regardless of a transfer.
The debtor under a promissory note should ensure that the note is returned and shredded upon settlement of the debt. Should the note, despite having been paid once, be transferred to a third party acting in good faith, the debtor risks having to pay the same debt twice.