A promissory note is a written promise by one person (maker) to pay a specific sum of money to another person (payee) on demand or at a fixed future date. It is legally binding and used in business transactions.
Quick Summary
- A promissory note is a written payment promise between two parties
- The maker promises to pay the payee a fixed amount
- Payment can be on demand or at a specified date
- It is simpler than a bill of exchange (only two parties involved)
- Widely used for loans, credit sales, and business financing in Nigeria
Detailed Explanation
What is a Promissory Note?
A promissory note is a financial document where one person writes a promise to pay money to another person. Think of it like an IOU (I Owe You) but more formal and legally strong.
According to the Bills of Exchange Act, a promissory note is “an unconditional promise in writing, made by one person to another, signed by the maker, engaging to pay on demand, or at a fixed or determinable future time, a certain sum in money to or for the order of a specified person or to bearer.”
How Does it Work?
Imagine Chidi borrows ₦500,000 from his friend Amaka to start a business. Instead of just saying “I will pay you back,” Chidi writes a promissory note. The note says: “I, Chidi Okafor, promise to pay Amaka Nwosu ₦500,000 on December 31, 2026.” He signs it and gives it to Amaka.
This document makes the debt official. If Chidi refuses to pay, Amaka can use the note in court as proof. The note protects both parties.
Parties Involved in a Promissory Note
Unlike a bill of exchange which has three parties, a promissory note has only two parties:
- The Maker: This is the person who writes and signs the note. The maker is the debtor who promises to pay. In our example, Chidi is the maker.
- The Payee: This is the person who receives the money. The payee is the creditor to whom payment is promised. In our example, Amaka is the payee.
Types of Promissory Notes
1. On Demand Promissory Note
This type has no fixed payment date. The payee can ask for payment anytime. For example: “I promise to pay Tunde Balogun ₦200,000 on demand.”
2. Time Promissory Note
This has a specific payment date. For example: “I promise to pay Ada Nnamani ₦300,000 on March 15, 2026.”
Common Uses in Nigeria
Business Transactions: When a trader buys goods on credit from a supplier, they may issue a promissory note. For example, a shop owner at Computer Village, Lagos, buys ₦2 million worth of laptops from a distributor and promises to pay in 90 days.
Personal Loans: Friends or family members use promissory notes to formalize loans. This prevents misunderstanding and disputes.
Bank Financing: Microfinance banks and cooperative societies in Nigeria often use promissory notes when giving loans to small businesses.
School Fees: Some private schools accept promissory notes from parents who need time to pay fees.
Advantages of Promissory Notes
- Legal Protection: The note serves as evidence in court if there is a dispute
- Clear Terms: The amount and payment date are written clearly
- Simple Process: Easy to create without complex procedures
- Flexible: Can be used for various transactions
- Transferable: The payee can transfer the note to another person (endorse it)
Disadvantages of Promissory Notes
- No Guarantee: If the maker has no money, the note is useless
- Forgery Risk: Fake notes can be created
- Legal Cost: Going to court to enforce payment costs money and time
- Limited Security: Unlike a cheque, a promissory note is not backed by a bank
Comparison Table: Promissory Note vs Bill of Exchange
| Feature | Promissory Note | Bill of Exchange |
|---|---|---|
| Number of Parties | Two (maker and payee) | Three (drawer, drawee, payee) |
| Nature | A promise to pay | An order to pay |
| Who Creates It? | The debtor (maker) | The creditor (drawer) |
| Acceptance Needed? | No acceptance required | Drawee must accept it |
| Liability | Maker is primarily liable | Drawer and acceptor are liable |
| Common Use | Personal loans, simple debts | International trade, complex transactions |
Common WAEC Exam Mistakes
1. Confusing Promise with Order: Many students say a promissory note is an “order to pay.” Wrong! It is a promise to pay. A bill of exchange is an order.
2. Wrong Number of Parties: Students list three parties (drawer, drawee, payee) for a promissory note. Remember: only two parties (maker and payee).
3. Who Creates It?: Students often think the creditor creates it. No! The debtor (maker) creates and signs the promissory note.
4. Acceptance Requirement: Some students say a promissory note needs acceptance like a bill of exchange. This is wrong. No acceptance is needed.
5. Merely Listing Features: WAEC examiners complain students just list points without explaining. When asked to “explain,” give details with examples.
Practice Questions
Multiple Choice Questions
1. A promissory note is a written promise made by:
a) The creditor to the debtor
b) The debtor to the creditor ✓
c) The bank to the customer
d) The drawer to the drawee
2. How many parties are involved in a promissory note?
a) One
b) Two ✓
c) Three
d) Four
3. Which of the following is NOT a feature of a promissory note?
a) It must be in writing
b) It contains an unconditional promise
c) It requires acceptance by the drawee ✓
d) It must be signed by the maker
4. The person who receives payment in a promissory note is called:
a) The drawer
b) The maker
c) The payee ✓
d) The drawee
Essay Questions
1. (a) Define a promissory note. (3 marks)
(b) State four features of a promissory note. (4 marks)
(c) Explain three differences between a promissory note and a bill of exchange. (6 marks)
Exam Tip: For part (a), use the legal definition from the Bills of Exchange Act. For part (b), simply state the features. For part (c), you must explain not just list – this means giving details about each difference.
2. Describe five circumstances in which a promissory note may be used in Nigeria. (10 marks)
Exam Tip: Don’t just write “business transactions.” Explain the specific situation. For example: “A trader at Onitsha Main Market buys ₦5 million worth of goods on credit and issues a promissory note promising to pay the supplier in 60 days.”
3. (a) Who are the parties to a promissory note? (2 marks)
(b) Explain the role of each party. (4 marks)
(c) State four advantages of using a promissory note in business. (4 marks)
Exam Tip: For part (b), don’t just name the parties. Explain what each person does. The maker creates and signs the note (debtor). The payee receives the payment (creditor).
Memory Aids
Remember the Difference:
- PROMISSORY NOTE = PROMISE (The maker promises to pay)
- BILL OF EXCHANGE = ORDER (The drawer orders the drawee to pay)
TWO Parties Mnemonic: M-P (Maker-Payee) – Only TWO letters, only TWO parties!
Who Creates What?:
- Promissory Note: Debtor creates it (Debtor starts with D, Debtor owes money)
- Bill of Exchange: Creditor creates it (Creditor wants money back)
Related Topics
To understand promissory notes better, read these related posts: