When Would My Healthcare Practice Use a Promissory Note?
What is a promissory note, when would you use one, and how does it differ from other loan documents?
If you are a business owner, you know that borrowing and lending money can be crucial in growing and sustaining your business. If you’re expanding your practice, bringing in a new business partner, or entering into a contract, your attorney (or the internet) might mention a promissory note. A promissory note can be a vital tool for helping you make smart decisions on behalf of your practice and can come in handy in a variety of situations.
What Is a Promissory Note?
A promissory note is a (typically shorter) financial document in which one party promises to pay another party a definite sum of money at a future date. In other words, it is a contract outlining the terms and conditions for borrowing and repaying the funds.
In the document, one party is considered the “borrower,” and one party is considered the “lender.” The amount is definite — or fixed — meaning it is not contingent on another factor. A promissory note would specify, for example, “Jane agrees to pay Susie $2,000,” not “Jane agrees to pay Susie the amount they agree is fair.”
Why Use a Promissory Note?
If you’re a lender, a promissory note allows you to document the terms of your loan. As a written agreement, it will be binding on the borrower. If you’re a borrower, the lender may require you to sign a promissory note to secure funding. Further, if you are trying to execute a business deal or are signing a letter of intent (LOI), your offer and willingness to sign a promissory note might persuade the potential lender of your commitment to repaying the debt and making good on your promises.
For healthcare providers who receive bonuses for signing, relocation, or retention, it is common to sign a promissory note to affirm that you will remain employed at the practice for a certain period. The employer may opt to forgive the loan if you stay at the practice for the stated period or may demand immediate, full payment if you leave before that date.
Because promissory notes are considered more “informal,” they are also a good choice when lending money to friends, family, or close colleagues.
Here are three common scenarios when you might use a promissory note for your healthcare practice.
Buying a Practice
If you’re purchasing a practice, you may need a large sum of money fast. A promissory note can help you secure the needed funding and assure the lender that you will repay the debt. Such a transaction may better lend itself to a loan agreement (as we’ll discuss later). However, a promissory note might be appropriate depending on the relationship between the parties. Are the parties amicable? Is the transaction relatively simple? If yes, a promissory note might be suitable.
Buying Equipment or Materials From Another Practice
A promissory note can help facilitate the exchange of medical equipment, supplies, or materials from another practice. Promissory notes can include installment payment schemes. Thus, a promissory note can help you obtain expensive items by paying for them little by little along the way.
Hiring Employees
If hiring employees or independent contractors, you could add a promissory note to their contract. Employers may use promissory notes to offer signing or retention bonuses to employees, where the promissory note is forgiven by the contract if the employee stays with the practice for a certain amount of time.
If you’re an employer, a promissory note could also serve as part of the “consideration” (essentially, a promise in exchange for a promise) for binding your employees to important contractual restrictions, like noncompetition agreements or nonsolicitation provisions. (For more information about consideration and other elements of a binding contract, see our blog, “Does a Contract Need To Be in Writing To Be Valid and Enforceable?”)
New employees might need loan money for moving costs, licensing fees, or other needed expenses as they start a new job. A promissory note can be an incentivizing tool to cover these initial costs while ensuring repayment.
What Will You Find in a Promissory Note?
Basic Information About the “Deal”
Promissory notes typically contain information about the loaned funds, such as:
- The size of the loan
- When and how the repayment of the money is due (e.g., lump-sum, installment, and on-demand payments)
- Interest rate ( if any) and how it will be calculated
- Penalty for late payment
Common Promissory Note Clauses
You’ll typically find other terms in a promissory note, such as those establishing:
The Relationship Between the Parties
Is the note establishing some sort of business relationship? For example, are the parties beginning a joint business venture together? The promissory note can document how the parties intend to be connected (or otherwise disconnected) legally.
Keep in mind that a business relationship should be documented in more than just a promissory note. That is, it should be formalized in your corporate organizing documents (e.g., your operating agreement or corporate bylaws), by a management services agreement, an employment or contractor agreement, or whatever other contract applies to your specific situation.
Whether the Loan Is Assignable
If you are the lender, do you want the borrower to be able to assign their obligation to pay to someone else? For instance, say you’re the landlord of a social work practice. Allowing an assignment of the loan can make sense if the practitioner-borrower wants to sell their practice and assign their lease to the person buying their practice.
Typically, lenders do not want the borrower to have the right to assign their debt to someone else. In the same vein, a borrower may have chosen their lender for a reason, and they may expressly not want the lender to assign their loan to someone else. If this is the case, the promissory note can contain an anti-assignment restriction.
Who Pays Attorneys Fees If There’s a Disagreement
If the parties get into a dispute, a promissory note can clarify who pays the attorneys’ fees required to resolve it. Sometimes, the promissory note will contain a “prevailing party” clause, stating that the prevailing party is entitled to reimbursement of their legal costs.
How is a Promissory Note Different From a Loan Agreement?
Loan agreements are formal contracts that document, in detail, the terms surrounding a lender’s loan of money to a borrower. In contrast, a promissory note is typically a less formal and less detailed legal instrument than a loan agreement.
Most small business or practice owners use loan agreements for their more formal lending relationships. They’re often used for higher-dollar transactions, such as mortgages, where the lender may want to ensure access to broader remedies, such as foreclosure, if the borrower defaults on the loan.
Another critical difference: loan agreements are almost always signed by both parties; they bind the borrower and the lender to the terms of the contract. In contrast, most promissory notes require only the borrower’s signature. They tend to be presented by the lender, written in the lender’s chosen language, and primarily aimed to bind the borrower to the lender’s terms.
Loan agreements tend to include more complex repayment terms, such as calculations of compound interest and early payoff options or penalties. Conversely, promissory notes tend to be used in situations of less complexity.
How is a Promissory Note Different From a Personal Guarantee?
A personal guarantee is an individual’s legal promise to repay a third party’s debts. In many cases, an individual needs to sign a personal guarantee on behalf of their business or practice. In other situations, the third party might be a family member or business partner. Lenders most often require personal guarantees when
- a business is still young and lacks an established credit history
- an individual borrower has a suboptimal credit score; or
- the borrower’s income doesn’t satisfy the lender’s guidelines.
You can use a personal guarantee to “promise” repayment on behalf of your business. However, if the business defaults on the loan, the lender can use that guarantee to collect the debt from your personal assets. Promissory notes can include personal guarantees — especially if the borrower wants to make their agreement more attractive to a skeptical lender.
Get Professional Support
While promissory notes are viewed as the “simpler” loan agreement, it’s still inadvisable to draft or sign one without counsel. First, you should check with an accountant to determine whether a promissory note creates any new tax implications for you or your business. Second, an experienced attorney can help you understand the different legal pieces of a promissory note, any hidden legal implications, and how to tailor a promissory note to your specific needs.
If you operate in any of the states where Jackson LLP has licensed attorneys, you can schedule a free consultation to learn more about how we can assist you with promissory notes or other legal documents.
This blog is made for educational purposes and is not intended to be specific legal advice to any particular person. It does not create an attorney-client relationship between our firm and the reader. It should not be used as a substitute for competent legal advice from a licensed attorney in your jurisdiction.