Demand Promissory Note

A Demand Promissory Note in the United States records a borrower's unconditional promise to repay a stated sum to the lender on agreed terms.

The legal framework for Demand Promissory Notes under UCC Article 3 distinguishes between negotiable and non-negotiable instruments. A Demand Promissory Note qualifies as a negotiable instrument under UCC § 3-104 if it satisfies four requirements: (1) it is an unconditional promise to pay a fixed amount of money; (2) it is payable to order or to bearer; (3) it is payable on demand or at a definite time; and (4) it does not state any other undertaking or instruction beyond what UCC § 3-104 authorizes. A negotiable Demand Promissory Note can be transferred to a holder in due course under UCC § 3-302, who takes the note free of personal defenses the maker could assert against the original payee — making the note a more freely marketable financial instrument.

The statute of limitations for enforcing a Demand Promissory Note is governed by UCC § 3-118(b), which provides that an action to enforce a demand note must be commenced within 6 years after the note's demand date. Because the limitations period begins when demand is made — not when the note is executed — a holder who never makes a formal demand faces uncertain limitations analysis. Courts in California (Code of Civil Procedure § 337), New York (CPLR § 213), and Texas (Civil Practice and Remedies Code § 16.004) have addressed this ambiguity differently, generally holding that the limitations period begins at the time a reasonable demand could have been made.

Demand Promissory Notes are widely used for family loans, business lines of credit, and employer-employee loan arrangements. For family loans, the IRS requires that loans between related parties bear interest at or above the applicable federal rate (AFR) published monthly by the IRS under IRC § 7872(f)(2) to avoid imputation of gift income to the lender and imputed interest income to the borrower. For demand notes, the relevant AFR is the short-term rate (for instruments with a term of 3 years or less). Below-market loans subject to IRC § 7872 are treated as if they bore interest at the AFR, with the difference between the AFR and the stated rate treated as a deemed payment from the lender to the borrower (a taxable gift or compensation, depending on the relationship).

The Demand Promissory Note differs from a Line of Credit Agreement in that a promissory note is a standalone payment obligation — once executed, it represents an absolute promise to pay the stated amount on demand. A Line of Credit Agreement governs a revolving borrowing arrangement under which the borrower may draw, repay, and redraw amounts up to a credit limit. Many commercial credit facilities combine both: a Line of Credit Agreement governs the borrowing mechanics, and each draw under the line is evidenced by a separate Demand Promissory Note or a single master note.

A US Demand Promissory Note is needed whenever a lender wants the flexibility to call a loan at any time — rather than committing to a fixed repayment schedule — while maintaining a formal written record of the obligation that is enforceable as a legal instrument.

Demand Promissory Notes are the standard instrument for family loans between parents and adult children, between siblings, or between other relatives. When parents loan money to a child for a home down payment, business startup, or emergency expense, a Demand Promissory Note bearing interest at or above the IRS short-term AFR (currently published monthly at IRS.gov) documents the transaction as a genuine loan rather than a gift, preserving the parents' estate planning flexibility and avoiding IRS gift tax scrutiny under IRC § 2501.

In the business context, Demand Promissory Notes are used for bridge loans between affiliated companies — particularly in corporate groups where a US parent company advances funds to a subsidiary pending permanent financing. The Demand Promissory Note documents the intercompany loan at arm's-length terms consistent with IRC § 482 transfer pricing requirements, preventing the IRS from recharacterizing the advance as a capital contribution.

Employer loans to employees — for relocation assistance, down payment assistance, or hardship loans — are commonly structured as Demand Promissory Notes. The demand feature allows the employer to accelerate repayment if the employee terminates employment, providing greater flexibility than a fixed-term loan. Employers in California must comply with California Labor Code § 224, which restricts deductions from wages, including deductions to repay employee loans, to circumstances where the deduction is authorized in writing by the employee.

In the private equity and venture capital context, convertible notes used for early-stage financing are frequently structured as demand notes with conversion features — they are payable on demand if not converted to equity before a specified maturity date. Law firms including Wilson Sonsini Goodrich & Rosati, Cooley LLP, and Gunderson Dettmer publish widely used convertible note templates for Silicon Valley startups that use demand note mechanics.

Real estate hard money lenders in California, Texas, Arizona, and Nevada — private lenders providing short-term bridge financing secured by real property — use Demand Promissory Notes or short-term fixed-term notes for bridge and rehab loans, enabling them to call the loan if the borrower fails to refinance or sell the property within the expected timeframe.

A properly drafted US Demand Promissory Note must contain specific provisions to be legally enforceable as a negotiable instrument under UCC Article 3 and to protect the lender's right to collect the full amount on demand. The following elements are essential.

The parties and date section identifies the maker (borrower) by full legal name and address, the payee (lender) by full legal name and address, and the date of execution of the note. For corporate or LLC makers, the note should identify the entity's full legal name as registered with its state of formation, the state of formation, and the name and title of the authorized signatory. The date of the note is the date the borrower signs — which may differ from the date the loan proceeds are advanced, particularly if the note is pre-signed before the funds are disbursed.

The principal amount clause states the exact dollar amount the maker promises to pay — in numerals and words to prevent alteration — and confirms that this amount has been received by the maker as a loan from the payee. Under UCC § 3-104(a)(1), the promise must be to pay a "fixed amount" of money; a note that allows the outstanding principal to fluctuate (as in a revolving credit facility) may not qualify as a negotiable instrument.

The interest rate clause specifies the annual interest rate applicable to the outstanding principal balance. For notes between related individuals, the stated rate must meet or exceed the IRS short-term applicable federal rate (AFR) under IRC § 7872 to avoid imputation of gift income. For consumer demand loans, the stated rate must comply with applicable state usury laws — California Constitution Article XV limits consumer loans below $2,500 to 10% per year; New York General Obligations Law § 5-501 limits most loans to 16% per year; Texas Finance Code § 302.001 sets the legal interest rate at 6% per year for commercial transactions without a written agreement.

The demand and payment provisions clause specifies how and when the payee may make a demand for payment, the address to which demand must be sent, the form of demand (written notice, electronic communication, or oral demand), and the number of days the maker has to pay after receiving demand. A note that states no notice period allows the payee to demand immediate payment, which may be commercially unreasonable. Most family and business demand notes provide for a 30-day payment period after written demand.

The default and acceleration clause addresses what constitutes a default beyond non-payment following demand — such as the maker's insolvency, bankruptcy filing under Title 11 of the United States Code, or material breach of any related security agreement — and confirms that upon any such default, the entire outstanding principal and accrued interest becomes immediately due and payable without further demand.

The governing law and enforcement clause specifies the state law that governs the note and the jurisdiction in which enforcement proceedings may be brought. For notes between parties in different states, the governing law selection must be made thoughtfully, as state usury laws, statute of limitations provisions, and enforceability rules differ materially.