Individuals and companies do not need to use a financial institution or bank to raise finance nor do they need to enter into a complicated legal contact to settle outstanding debts between each other.
For example, a private individual might agree to provide start-up capital to a family member for a new business venture; or a parent company may decide to step in and fund the short-term capital requirements of a subsidiary company.
This type of lending arrangement between two (or more) parties that are connected to each other in some way, doesn’t necessarily require a full-blown, formal lending agreement with all the cost and legal complexities that goes with a contract of that nature.
Instead, the lending arrangements between the parties can be structured by way of a legal document known as a Promissory Note. This is a much more informal agreement and should probably only be used when there is a degree of trust between the parties.
What is a Promissory Note?
A Promissory Note is essentially a written promise by one person (the borrower) to pay another person (the lender) an agreed sum of money at a specified future date. In other words, it’s an IOU, except one that is formalised as a legal agreement, which is binding and enforceable.
The terms of the agreement should be relatively straightforward; but should include names of the parties, the amount borrowed, repayment date agreed, any interest charged and what should happen if the borrower fails to repay the amount due.
A loan agreement of this nature is unlikely to include any security as that involves a level of cost and complexity that is perhaps not needed when the borrower and lender are known to each other.
However, like any legal contract, setting out the agreed terms on a formal basis can help to avoid any disputes and misunderstandings at a future date.
To see an example of a simple Promissory Note Agreement created by the online lawyers, LawDepot, please click here.
Promissory Note case study: Victoria Oil and Gas (VOG)**
Promissory Notes are arguably quite an informal loan arrangement between two parties so it’s unusual to see an AIM listed company enter into such a facility.
On 17th April 2020, Victoria Oil and Gas** (VOG) announced that its wholly-owned subsidiary, Gaz Du Cameroun (GDC), had entered into a Promissory Note agreement with one of its customers.
GDC had been supplying gas to its biggest customer – ENEO – under a so-called Take-or-Pay, Gas Supply Agreement (GSA). This type of contract means that ENEO is obliged to pay GDC for a specified, minimum amount of gas, irrespective of whether they use the gas or not.
It became apparent in early to mid 2019 that ENEO was experiencing financial difficulties and was therefore unable to pay GDC for the gas supplied, in accordance with the terms of their GSA.
Between the period May 2019 and March 2020, ENEO failed to settle invoices totalling USD 5.2 million which had been raised by GDC; clearly an unsustainable position for any small company with financial obligations of its own.
In order to resolve this financial impasse, ENEO provided GDC with four Promissory Notes amounting to USD 2.9 million. These effectively cover the proposed payment of all the unpaid invoices issued by GDC between May 2019 and August 2019.
GDC has in turn used these Promissory Notes as collateral against a bridging facility agreed by their bank (who coincidentally also happen to be ENEO’s bank). The Notes are expected to mature (be cashed in) at monthly intervals between May 2020 and August 2020.
In effect, GDC expect to secure settlement of all their unpaid invoices amounting to USD 2.9 million each month over a four month period, beginning in May 2020, on the basis of these Promissory Notes.
Apparently, this is not the first time that VOG has entered into such an arrangement with ENEO. It also did so in 2017, when ten Promissory Notes were issued to settle outstanding arrears.
**Victoria Oil and Gas Plc was cancelled from AIM on 16th December 2022.
Corporate finance
To learn more about corporate finance and the types of finance arrangements it includes, please click here.
