To Note Or Not To Note – Promissory Note in Commercial Lending

[Note: This article was originally posted on July 9, 2021.]

“Undesirable” consequence of “confusion & doubt”

In 1976, a UK lawyer questioned the wisdom of the common practice in US to memorize a commercial lending transaction with both a loan agreement and a promissory note:[1]

“[M]any English lawyers regard them [American-style promissory notes] as undesirable. I think most English lawyers would advise strongly against the practice of setting out the obligations as between borrower and lender in two contemporaneous documents expressed in different terms. The opportunities for confusion and doubt and legal difficulty involved in such a practice are something which lawyers are – or ought to be – brought up to avoid.”

Given such an “undesirable” consequence of “confusion & doubt” by using a promissory note and a loan agreement “contemporaneously”, the question is whether it makes sense to continue this practice. To answer the question, it may be useful to find out why US adopted this practice in the first place.

Historical developments – divorce from UK practice

As the UK lawyer noted, because of the “undesirable” consequence associated with the use of “contemporaneous” documents in a transaction, in whole or in part[2], it appears UK bankers have historically avoided using promissory notes in commercial lending, relying instead on bills of exchange primarily.[3] In US, however, as the banking industry began to develop after the revolutionary war, the influence of UK banking practice began to wane, and promissory notes eventually replaced bills of exchange in commercial lending by the 100th birthday of the new nation. (See, eg, Summers, in Footnote 3. “[T]he bill of exchange, so prominent from Colonial times, slowly disappeared and was replaced by the promissory note as the most common credit instrument, a transition largely completed by the end of the Civil War”.)

So, why did US bankers & lawyers ignore the wisdom of their UK counterparts and preferred promissory notes over bills of exchange, in spite of the potential “confusion and doubt” (and any other potential disadvantages) arising from the use of two “contemporaneous” documents?

To answer the question, one NY lawyer proposed a few explanations, again in 1976.[4] First, UK imposed a stamp duty on promissory notes in 1782, which remained effective for almost 200 years. In US, on the other hand, stamp taxes for promissory notes were enacted as wartime emergency measures and repealed relatively quickly.[5] Second, as US became more mobile and less structured, borrowers could relocate to another state easily. US bankers might have preferred a simple piece of paper, without the need to produce the full bank records, to sue borrowers across state lines. Third, prior to the enactment of the Federal Reserve Act in 1913, there was uncertainty whether national banks in US had the corporate power to accept bills of exchange drawn on themselves. And fourth, habit. That is, the participants in US commercial lending – bankers, borrowers, bank regulators, judges, juries, etc – had been accustomed to promissory notes and found no compelling reasons to change.[6]

From the above historical analysis, it’s fair to conclude that the adoption of promissory notes in commercial lending in US served primarily as a substitute of the bills of exchange used in UK. However, in a typical promissory note, the obligor for payment (the borrower) is also a party to the loan agreement. The obligor for payment in a typical bill of exchange, on the other hand, is not the borrower, and therefore not a party to the loan agreement.[7] Therefore, replacing the bill of change by the promissory note results in the “undesirable” consequence of using “contemporaneous documents” in a transaction.

The next question then is whether, in the current environments, such an “undesirable” consequence (and any other additional disadvantages) may outweigh the benefits, if any, that promissory notes can provide, and thus whether it makes sense to continue to use promissory notes in conjunction with a loan agreement.

Modern analysis of pros & cons – noteless syndicated loans

Many commentators have analyzed the advantages & disadvantages of promissory notes under the modern-day legal frameworks for commercial lending in US. (See, eg, here, here, & Bellucci and McCluskey, The LSTA’s Complete Credit Agreement Guide (2nd ed. 2017), pp.200-203.) So, I will only briefly summarize the main points here.

In terms of the advantages of a promissory note, the main one is to “evidence” the associated loan. By my interpretation, this means the ability to show the world (ie, the borrower, regulators, courts, juries, third parties, …) the existence of the loan in a short, simple, and easy-to-understand document, in contrast with the lengthier and more complicated loan agreement. Additional notable advantages include negotiability[8], expedited court proceedings (mainly in NY[9] and some Latin America countries[10]), and the ability to pledge the note to the Federal Reserve at its discount window[11].

On the other hand, the disadvantages of a promissory note include difficulties in safekeeping and locating the note, the need to amend and re-issue the promissory note when the loan agreement is amended or when the loan principal amount changes under the existing loan agreement, the potential for inconsistencies between the promissory note and the loan agreement (as the UK lawyer noted), the additional work required to ensure consistency between the documents, and, particularly for syndicated loans, the logistic burdens created when a lender assigns all or part of its commitment (requiring collection of old notes to issue new notes).

It has been argued, however, that except for the “evidence” advantage, most of the other advantages offered by a promissory note are either not available (negotiability[12]) or can be accomplished by a loan agreement (expedited proceeding & pledge at Federal Reserve[13]) in most instances. This is particularly so for syndicated loans, which involve mostly sophisticated parties in complicated transactions, and the combined disadvantages of the promissory note outweigh its weakened advantages. As a result, in recent years, most syndicated loans have been “noteless”, making promissory notes optional by the request of individual lenders, and relying primarily on the loan agreements to memorize the transactions.[14]

Appropriate use of promissory notes – careful evaluation and practical expectation

Despite the “noteless” trend in syndicated loan transactions, not all commercial lending transactions need to forsake the promissory note. It may still be beneficial to have a short, simple, and easy-to-understand document to “evidence” the existence of the loan. Care & caution must be exercised, however, to reduce, minimize, or avoid the potential disadvantages embodied in the use of two “contemporaneous” documents in a single transaction.

First of all, the reality is a short and simple document, as desirable as it may be, cannot be expected to properly memorize a complicated transaction. This deficiency may be reflected on the availability of the NY expedited proceeding afforded to a promissory note. Under NY laws, the expedited proceeding may not be available to the lender if the promissory note and the loan agreement have become so “intertwined” at the time of breach.[15] Consider the case in Bonds Financial v. Kestrel Technologies[16]. There, the loan agreement of a resolving credit included events of default other than the failure to make payments. The borrower defaulted on a non-monetary term under the revolving loan agreement, which accelerated payment under the promissory note, and the lender instituted an expedited proceeding based on the promissory note. The court held that the expedited proceeding was not available pursuant to the promissory note, because it was necessary to reference an external document, the loan agreement, to determine whether an event of default had occurred.

Therefore, when structuring a loan transaction, the parties should carefully evaluate the interactions between the promissory note and the loan agreement (and other loan documents such as the mortgage[17]) and the potential of reduced or lost benefits from the promissory note, weigh the advantages and disadvantages afforded by using the note, and consider the option of a “noteless” loan transaction. This is particularly so when the promissory note references the loan agreement, which adds to the “intertwine-ness” between the documents (thus reducing the availability of the NY expedited proceeding) and also erodes the negotiability of the note.

In the minimum, a control clause should be included in both the promissory note and the loan agreement and specify which document should control in the event of inconsistencies.

[1] Richard G.A. Youard, Promissory Notes in International Loan Transactions: An English View, 4 INT’l Bus. LAW. 259 (1976).

[2] One author suggested that the UK stamp duty imposed on promissory notes in 1782 might have been another reason for the UK practice against promissory notes. Bruce W. Nichols, Some Observations on the American Approach to the Use of Notes in International Lending, 4 INT’l Bus. LAW. 239 (1976).

[3] See, e.g., Youard, supra; Nichols, id. (“English banks […] seem chiefly to have supplied credit by discounting bills of exchange held by customers, not the notes of such customers.”; Bruce J. Summers, Loan Commitments to Business in United States Banking History, Economic Review, vol. 61, September/October 1975, pp.15-23.

[4] Nichols, supra in Footnote 2.

[5] Florida currently imposes stamp taxes on promissory notes.

[6] The NY lawyer also suggested “transferability” of promissory notes (as opposed to loan agreements) as another reason for their continued use, particularly the ability to pledge promissory notes at the Federal Reserve. This reason, however, is now out of date, as most loan agreements are now transferrable, and the Federal Reserve currently accepts loan agreements as collateral. The latter subject will be discussed later in this article.

[7] In a typical bill of exchange associated with a trade, the seller (beneficiary) borrows from the seller bank (which may or may not be the drawee), which is documented by the loan agreement, while the buyer (drawer) orders the buyer bank to pay the seller (beneficiary), which is documented by the bill of exchange.

[8] Under UCC Article 3, an assignee of a “negotiable” instrument who qualifies as a “holder in due course” takes the instrument free and clear of most claims and defenses afforded to the maker of the instrument against the original holder. NY UCC 3-302 & 3-305. See also Footnote 12.

[9] NY CPLR 3213, titled “Motion for Summary Judgment in lieu of Complaint”, provides an expedited proceeding for enforcing an “instrument for the payment of money only”.

[10] See, eg, The LSTA’s Complete Credit Agreement Guide, supra at 201-202.

[11] The LSTA’s Complete Credit Agreement Guide, supra at 202.

[12] Under UCC Article 3, a “negotiable” instrument must include an unconditional promise or order to pay and all essential terms. NY UCC 3-104(1)(b). Most modern day promissory notes refer to the associated loan agreements and thus do not satisfy these requirements. See, eg,

[13] The Federal Reserve began to accept noteless loans as collateral in late 1990s. The LSTA’s Complete Credit Agreement Guide, supra at 202.

[14] The LSTA’s Complete Credit Agreement Guide, supra at 202-203. “[W]ith few exceptions [syndicated loan] lenders today no longer generally request promissory notes of the borrower”.

[15] Mlcoch v Smith, 173 AD2d 443, 444 (NY App Div. 2nd Dept. 1991). (“[T]he general rule is that the breach of a related contract cannot defeat a motion for summary judgment on an instrument for money only unless it can be shown that the contract and the instrument are “intertwined” and that the defenses alleged to exist create material issues of triable fact”.

[16] Bonds Financial, Inc. v. Kestrel Technologies, LLC, 48 AD 3d 230 (NY App Div. 1st Dept. 2008)

[17] In some states, a mortgage (or deed or deed of trust) must recite the amount of debt secured by the mortgage. If the mortgage references a promissory note, and the debt principal amount changes, a new note may need to be issued, and the mortgage will need to make sure to reference the correct note. See,