PROMISSORY NOTE AND ITS IMPORTANCE
Under supervision of Ms. of Ms. Chandani Sharma Amity Law School, Amity University, Noida
PRABJOT KAUR A3211110181 BA.L.LB(H), 2011-16 SEC- A
ACKNOWLEDGEMENT
I have taken efforts in this project. However, it would not have been possible without the kind support and help of many individuals and organizations. I would like to extend my sincere thanks to all of them. I am equally grateful to my teacher. She gave me moral support and guided me in different matters regarding the topic. She had been very kind and patient while suggesting me the outlines of this project and correcting my doubts. I thank her for her overall supports. Despite of her busy schedule she never ignored to help me.
PRABJOT KAUR
TABLE OF CONTENT
1. Introduction 2. History 3. Why a promissory note is important between friends & family 4. promissory notes law & legal definition 5. What are the different types of promissory notes? 6. Understanding promissory notes for small businesses 7. The advantages of a promissory note 8. Bibliography
INTRODUCTION
A promissory note is a legal instrument (more particularly, a financial instrument), in which one party (the maker or issuer ) promises in writing to pay a determinate sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. If the promissory note is unconditional and readily salable, it is called a negotiable instrument. Referred to as a note payable in accounting (as distinguished from accounts payable), or commonly as just a "note", it is internationally defined by the Convention providing a uniform law for bills of exchange and promissory notes, although regional variations exist. Bank note is frequently referred to as a promissory note: a promissory note made by a bank and payable to bearer on demand. Mortgage notes are another prominent example. Promissory notes are a common financial instrument in many jurisdictions, employed principally for short time financing of companies. Often, the seller or provider of a service is not paid upfront by the buyer (usually, another company), but within period the length of which has been agreed upon by both the seller and the buyer. The reasons for this may vary; historically, many companies used to balance their books and execute payments and debts at the end of each fiscal month; any product bought before that time would be paid only then. Depending on the jurisdiction, this deferred payment period can be regulated by law; in countries like France, Italy or Spain, it usually ranges between 30 to 90 days after the purchase. When a company engages in many of such transactions, for instance by having provided services to many customers all of whom then deferred their payment, it is possible that the company may be owed enough money that its own liquidity position (i.e., the amount of cash it holds) is hampered, and finds itself unable to honour their own debts, despite the fact that by the books, the company remains solvent. In those cases, the company has the option of asking the bank for a short term loan, or using any other such short term financial arrangements to avoid insolvency. However, in jurisdictions where promissory notes are commonplace, the company (called the payee or lender ) can ask one of its debtors (called the maker , borrower or payor ) to accept a promissory note, whereby the maker signs a legally binding agreement to honour the amount established in the promissory note (usually, part or all its debt) within the agreed period of time.[3] The lender can then take the promissory note to a financial institution (usually a bank, albeit this could also be a private person, or another company), that will exchange the promissory note for cash; usually, the promissory note is cashed in for the amount established in the promissory note, less a small discount. Once the promissory note reaches its maturity date, its current holder (the bank) can execute it over the emitter of the note (the debtor), who would have to pay the bank the amount promised in the note. If the maker fails to pay, however, the bank retains the right to go to the company that cashed the promissory note in, and demand payment. In the case of unsecured promissory notes, the lender accepts the promissory note based solely on the maker's ability to repay; if the maker fails to pay, the lender must honour the debt to the bank. In the case of a secured promissory note, the lender accepts the promissory note based on the maker's ability to repay, but
the note is secured by a thing of value; if the maker fails to pay and the bank reclaims payment, the lender has the right to execute the security. Thus, promissory notes can work as a form of private money. In the past, particularly during the 19th century, their widespread and unregulated use was a source of great risk for banks and private financiers, who would often face the insolvency of both debtors, or simply be scammed by both. The terms of a note usually include the principal amount, the interest rate if any, the parties, the date, the terms of repayment (which could include interest) and the maturity date. Sometimes, provisions are included concerning the payee's rights in the event of a default, which may include foreclosure of the maker's assets. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand of the lender. Usually the lender will only give the borrower a few days' notice before the payment is due. For loans between individuals, writing and signing a promissory note are often instrumental for tax and record keeping. A promissory note alone is typically unsecured,[5] but these may be used in combination with security agreements such as mortgage, in which case they are called mortgage notes.
INTERNATIONAL LAW
Definition and usage of promissory notes are internationally established by the Convention providing a uniform law for bills of exchange and promissory notes, signed in Geneva in 1930.[6] Article 75 of the treaty stated that a promissory note shall contain:
the term " promissory note" inserted in the body of the instrument and expressed in the language employed in drawing up the instrument an unconditional promise to pay a determinate sum of money. a statement of the time of payment; a statement of the place where payment is to be made; the name of the person to whom or to whose order payment is to be made; a statement of the date and of the place where the promissory note is issued; the signature of the person who issues the instrument (maker).
UNITED STATES LAW
In the United States, a promissory note that meets certain conditions is a negotiable instrument regulated by article 3 of the Uniform Commercial Code. Negotiable promissory notes called mortgage notes are used extensively in combination with mortgages in the financing of real estate transactions. One prominent example is the Fannie Mae model standard form contract Multistate Fixed-Rate Note 3200, which is publicly available.[7] Promissory notes,
or commercial papers, are also issued to provide capital to businesses. However, Promissory Notes act as a source of Finance to the company's creditors. The various State law enactments of the Uniform Commercial Code define what is and what is not a promissory note, in section 3-104(d): § 3-104. NEGOTIABLE INSTRUMENT.... (d) A promise or order other than a check is not an instrument if, at the time it is issued or first comes into possession of a holder, it contains a conspicuous statement, however expressed, to the effect that the promise or order is not negotiable or is not an instrument governed by this Article.
Thus, a writing containing such a disclaimer removes such a writing from the definition of negotiable instrument , instead simply memorializing a contract.
BRITISH LAW § 83. BILLS OF EXCHANGE ACT 1882. Part IV. Promissory note defined
(1)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 sum certain in money, to, or to the order of, a specified person or to bearer. (2)An instrument in the form of a note payable to maker’s order is not a note within the meaning of this section unless and until it is indorsed by the maker.
(3)A note is not invalid by reason only that it contains also a pledge of collateral security with authority to sell or dispose thereof. (4)A note which is, or on the face of it purports to be, both made and payable within the British Islands is an inland note. Any other note is a foreign note.
HISTORY Historically, promissory notes have acted as a form of privately issued currency. Flying cash or feiqian was a promissory note used during the Tang dynasty (618 – 907). Flying cash was regularly used by Chinese tea merchants, and could be exchanged for hard currency at provincial capitals. According to tradition, in 1325 a promissory note was signed inMilan. There is evidence of promissory notes being issued in 1384 between Genova and Barcelona, although the letters themselves are lost. The same happens for the ones issued in Valencia in 1371 by Bernat de Codinachs for Manuel d'Entença, a merchant from Huesca (then part of the Crown of Aragon), amounting a total of 100 florins. In all these cases, the promissory notes were used as a rudimentary system of paper money, for the amounts issued could not be easily transported in metal coins between the cities involved. Ginaldo Giovanni Battista Strozzi issued an early form of promissory note in Medina del Campo (Spain), against the city of Besançon in 1553. However, there exists notice of promissory notes being in used in Mediterranean commerce well before that date. DIFFERENCE FROM IOU
Promissory notes differ from IOUs in that they contain a specific promise to pay along with the steps and timeline for repayment as well as consequences if repayment fails. [12] IOUs only acknowledging that a debt exists.[13][14] In common speech, other terms, such as "loan", "loan agreement", and "loan contract" may be used interchangeably with "promissory note" but these terms do not have the same legal meaning.[citation needed ]
DIFFERENCE FROM LOAN CONTRACT
A promissory note is very similar to a loan - each is a legally binding contract to unconditionally repay a specified amount within a defined time frame - but a promissory note is generally less detailed and rigid than a loan contract. For one thing, loan agreements often require repayment in instalments, while promissory notes typically do not. Furthermore, a loan agreement usually includes the terms for recourse in the case of default, such as establishing the right to foreclose, while a promissory note does not. Also, while a loan agreement requires signatures from both the borrower and the lender, a promissory note only requires the signature of the borrower.
Negotiability
Negotiable instruments are unconditional and impose few to no duties on the issuer or payee other than payment. In the United States, whether a promissory note is a negotiable instrument can have significant legal impacts, as only negotiable instruments are subject to Article 3 of the Uniform Commercial Code and the application of the holder in due courser ule. The negotiability of mortgage notes has been debated, particularly due to the obligations and "baggage" associated with mortgages; however, in mortgages notes are often determined to be negotiable instruments. In the United States, the Non-Negotiable Long Form Promissory Note is not required.
WHY A PROMISSORY NOTE IS IMPORTANT BETWEEN FRIENDS & FAMILY A promissory note is a document that includes a promise to repay a loan, the loan amount and the repayment terms. Think twice about making loans, especially if doing so could leave you short of money to pay household expenses. Avoid the temptation to skip writing a promissory note if you do lend a friend or family member money. The note can help you recoup your money if the borrower reneges on the promise to repay you. Relationship Preservation A promissory note can help protect your relationship with friends or family members and prevent misunderstandings after you lend them money. The note moves the loan beyond your personal relationship and makes it a business transaction. Friends and family members shouldn't take offense to signing a promissory note because you're giving them a loan when a bank probably won’t. A promissory note also makes it clear to everyone involved that the money you're providing isn't a gift. Payment Schedule Sometimes family and friends may think it's OK to blow off repaying a l oan to you because you’re not a traditional lender. A promissory note helps prevent that notion by formalizing the repayment schedule the way a bank does. For example, the note may say the borrower has to make payments in a specified amount on the first day of each month until the loan is repaid. Give the borrower a receipt for each payment and keep a copy on hand to avoid disagreements over how many payments you’ve received. Tax Issues Money you give friends or family members can have tax consequences. A promissory note provides official documentation of a loan if the Internal Revenue Service ever audits you. For 2012, for example, taxpayers can give someone up to $13,000 without having to pay a gift tax. You can avoid the tax if you lend someone more than that and cite an interest charge on the promissory note. However, the interest charge on the loan must at least equal the most current applicable federal rate listed on the Internal Revenue Service website. Considerations Examples of promissory notes for personal loans are available online free of charge, or for a fee. You may want an attorney to write a promissory note for you to ensure the loan terms are correct. Some friends and family members won't repay a loan even if they sign a promissory note. So, you may have to sue them in small claims court to get your money back. In such cases, the promissory note will serve as proof to a judge that you made a loan that the borrower agreed to repay.
PROMISSORY NOTES LAW & LEGAL DEFINITION Promissory Note: A promissory note is a written promise to pay a debt. An unconditional promise to pay on demand or at a fixed or determined future time a particular sum of money to or to the order of a specified person or to the bearer. Cognovit Note: A cognovit note is a note in which the maker acknowledges the debt and authorizes the entry of judgment against him or her without notice or a hearing : a note containing a confession of judgment. This type of note is not valid in many States. Collateral Note: A collateral note is a note secured by collateral. Same as secured note. Demand Note: A demand note is a note payable on demand from the person who is owed the money. Floating Note: A floating rate note (or adjustable rate n ote) is a note where interest varies. Recourse Note: A recourse note is a note where the default may result in loss of collateral and also personal suit and judgment. Most notes are recourse notes. Renewal Note: A renewal note is a note that renews a previous note due date. Unsecured Note: An unsecured note is a note that is not secured by any collateral but only the promise to pay. Does a promissory note have to be recorded? Generally, a promissory note does not have to be recorded. Who must sign a promissory note? All borrowers must sign. The lender is generally not required to sign but may sign. A negotiable instrument is a check, promissory note, bill of exchange, security or any document representing money payable which can be transferred to another by handing it over (delivery) and/or endorsing it (signing one's name on the back either with no instructions or directing it to another). A negotiable instrument is a contract and subject to the rules governing contract law. However, a negotiable instrument may be distinguished from an ordinary contract by the fact that a negotiable instrument may be written in a way that makes it transferable. This quality of negotiation generally allows the instrument to be used as a substitute for money by holders in due course, despite the defensive claims between the original parties who drafted the negotiable instrument. In order to be negotiable, the bill or note must be payable to order, or to bearer. Some promissory notes contain a clause making them non-negotiable.
WHAT ARE THE DIFFERENT TYPES OF PROMISSORY NOTES? There are several different types of promissory notes, depending on the type of loan that was issued.The different kinds of promissory notes include:
Personal Promissory Notes : These are used to document a personal loan from a friend or family member. Although many people tend to avoid legal writings when dealing with trusted acquaintances, the use of a promissory note actually demonstrates good faith and effort on behalf of the borrower. Commercial : Promissory notes are almost always a requirement when dealing with commercial lenders such as a bank. Most commercial promissory notes are similar to personal notes, although they can be stricter. If the borrower defaults, the commercial lender is usually entitled to immediate repayment on the balance. Further, default can result in a lien on the borrower’s property in order to obtain payments. Real Estate: These are similar to commercial notes with respects to the default consequences. In this case, a lien is placed on the home or other real property. If default on a mortgage results in a lien, the information becomes public record and can affect the borrowers credit or purchasing abilities in the future. Investments : In a business setting, promissory notes are sometimes exchanged in order to raise capital for the business. This type of note may be a type of security interest and would thus be regulated by securities laws. These notes often contain clauses dealing with returns of investment for a certain time period.
Promissory notes are useful and necessary tools that are beneficial for both the lender and the borrower. With a promissory note, the lender gains additional assurance that their loan will be repaid in a timely and legitimate manner. For the borrower, the note can provide important information regarding his or her rights. What Happens If I Default on a Promissory Note? Promissory notes are legally binding documents, even if they are considered to be negotiable. Negotiable simply means that the document may be altered by a later agreement, and changes must usually be enforced by further monetary consideration.
If the borrower defaults on the note, there can be several consequences. First, the lender may initiate a lawsuit in order to force the debtor to complete the payments. In some instances, defaulting on one payment can result in the debtor collecting on the entire balance. For example, suppose the lender made a loan of $10,000 to the borrower, and the borrower has already made payments totaling $5,000. If they default on the next payment, the borrower may be legally entitled to collect the remaining $5,000 immediately.
Default can also result in a lien being placed on the borrower’s property. Additionally, if the default was made with a malicious or criminal intent, the debtor could be subject to penalties under criminal laws. Finally, failure to fulfill a promise recorded in a promissory note can result in poor credit scores. Violations can even effect child custody rights, particularly in the case of repeated or habitual defaults. Do I Need a Lawyer for Claims Regarding Promissory Notes? Anytime a loan is made, it should be recorded in a promissory note. Whether you are the lender or the borrower, you should work with a lawyer, who will help you draft and review the written instrument. If you have defaulted on a promissory note, an attorney can help you determine if any defenses are available. If you are a lender and the borrower has defaulted on a loan, your lawyer can discuss your options for recovering damages.
UNDERSTANDING PROMISSORY NOTES FOR SMALL BUSINESSES
A promissory note sets out the repayment terms when you borrow money. There are several ways to structure repayment -- all with advantages and disadvantages. It pays to learn the ins and outs of each repayment plan type so that you can choose the best method for your business. When Should I Use a Promissory Note?
If you borrow start-up cash for your business from a commercial lender, the lender will require you to sign a promissory note. You should also use a promissory note when borrowing money from a friend or relative. Documenting the loan can do no harm, and it can head off misunderstandings about whether the money is a loan or gift, when it is to be repaid, and how much interest is owed. It also documents the terms of the loan in case the IRS comes sniffing around with a business audit.
TYPES OF REPAYMENT SCHEDULES
Banks provide their own promissory note forms. If you borrow from a friend or relative, you'll need to use a promissory note from form books or software. The legal and practical terms of promissory notes can vary considerably, but the most important thing is to pick a repayment plan that's right for you. Following are four different approaches. 1. Amortized Payments
With amortized payments, you pay the same amount each month (or year) for a specified number of months (or years). Part of each payment goes toward interest, and the rest goes toward principal. When you make the last payment, the loan and interest are fully paid. In legal and accounting jargon, this type of loan is fully amortized over the period that you make payments. (You've probably dealt with an amortized repayment schedule before, when paying off a car loan or a mortgage.) Once you know the terms of the loan (the amount you want to borrow, the interest rate, and the time over which you'll make payments), you can figure out the amount of the payments using software such as Intuit's Quicken or Quickbooks, or an online calculator. Or you can use a printed amortization schedule, which is widely available from commercial lenders, business publishers, and local libraries. 2. Equal Monthly Payments and a Final Balloon Payment
This type of repayment schedule requires you to make equal monthly payments of principal and interest for a relatively short period of time. Then, after you make the last installment payment, you must pay the remaining principal and interest in one large payment, called a balloon payment.
Because of the lower monthly payments during the course of the loan, you can keep more cash available for other needs. Of course, when you're thinking about those nice low payments, don't forget the big balloon payment waiting around the corner. Balloon payments can have extra risks. If you plan to take out a new loan when it's time to pay the balloon payment, you're gambling that interest rates will stay the same or go lower over the life of the loan. And if you're buying an asset (such as a building) that you plan to sell quickly to pay off the loan before the balloon payment comes due, you're gambling that the asset will not depreciate.
3. Interest-Only Payments and a Final Balloon Payment
With an interest-only loan, you repay the lender by making regular payments of only interest over a number of months or years. The principal does not decrease. At the end of the loan term, you must make a balloon payment to repay this principal and any remaining interest. The obvious advantage of this arrangement is the low payments. And, if you find yourself in the happy situation of having extra cash, you can usually prepay principal. But over the long term, you'll pay more interest because you're borrowing the principal for a longer time. For instance, on a $20,000 loan, paid back in four years, you would pay almost $3,000 less by making equal amortized payments than if you made interest-only pa yments plus a final balloon payment.
4. Single Payment of Principal and Interest
Some loans, especially those from friends and family members, don't require regular payments of interest and/or principal. Instead, you pay off the loan all at once, at a specified future date. This payment includes the entire principal amount and the accrued interest. Borrowing money on these terms is best for a short-term loan, or if the lender isn't worried about on-time repayment. You are not likely to get this kind of deal from a commercial lender
THE ADVANTAGES OF A PROMISSORY NOTE A promissory note is a written contract that specifically deals with agreements between a person who wants to lend money and a person who wishes to borrow. As the name states, it is a promise to pay back the funds. As the lending party, the advantages of getting the borrower to sign a promissory note largely outweigh any downsides. Identification A promissory note lists key details of a loan arrangement, including the principal (payback) amount and due date or payment. It clearly identifies both the borrower and lender by name and contact information. If the lender requires interest as a condition of the agreement, it also shows the interest rate and whether the calculation is based on simple or compounding interest. Clarity Regarding Default Terms One advantage of having a promissory note is that it clearly outlines all terms of the borrowing arrangement so as to avoid unnecessary disputes. The note also commonly lists terms of default, such as an acceleration of the debt's due date. Also, if the borrower pledges collateral in case of default, such as a valuable piece of jewelry or car, the lender can use the note to attempt to claim the asset. Document Loan and Purpose With a promissory note the purpose of the loan is outlined clearly on paper. This is very useful information to have on hand for the lender's records. If the loan is properly documented, the lender might be able to write off the debt for a tax deduction. Otherwise, without proof of the agreement the loan is likely to be considered a gift -- especially if the loan is between two family members. Use the Note for Justice Another advantage of a promissory note is that it is clear evidence if the lender wants to seek a judgment in court. Oftentimes, with verbal lending agreements the borrower's story conflicts with that of the lender or the borrower denies responsibility for the loan outright. A thoroughly written and signed promissory note helps eliminate those concerns
Advantages for promissory note holders (goods buyers): o
o o
deferment of payment for goods purchased through issuance of a promissory note without diverting current funds; possibility of documenting the pledge by one of the counteragents or by both parties; saving on costs in the event of early redemption of promissory note (by redeeming at the price below the nomin al value). Advantages for promissory note holders (goods sellers):
o
prompt payment for goods shipped.
Reverse promissory note accounting means form of accounting whereby the promissory note holder promises the Bank to buy out the accounted promissory notes before their maturity date. Advantages for promissory note issuers (goods buyers): o
o
deferment of payment for goods supplied through issuance of a promissory note without diverting current funds; the pledge is documented by the counteragent – goods seller. Advantages for promissory note holders (goods sellers):
o
opportunity to temporarily increase current funds by selling a Bank’s promissory note fo r a specific term. Non-recourse promissory note accounting : under an accounting agreement, the holder is not responsible for paying full price for the promissory note but sells the promissory note to the Bank at an agreed-upon price. Advantages for promissory note issuers (goods buyers):
o
o
deferment of payment for goods supplied through issuance of a promissory note without diverting current funds; saving on costs in the event of early redemption of promissory note (by redeeming at the price below the nominal valu e). Advantages for promissory note holders (goods sellers):
o o
o
prompt payment for goods shipped; promissory note holder presentin g the note for accou nting pro vides the bank a document package similar to the doc ument package req uired for loan applic ations; bank accounts promissor y notes under accounting agreement with the promissory note holder;
BIBLIOGRAPHY
http://wiki.fool.com/The_Advantages_of_a_Promissory_Note http://www.pib.com.ua/en/corp/credits/discounts/ http://www.nolo.com/legal-encyclopedia/understanding-promissory-notes-small-businesses29729.html http://definitions.uslegal.com/p/promissory-notes/ http://budgeting.thenest.com/promissory-important-between-friends-family-23649.html http://www.legalmatch.com/law-library/article/different-types-of-promissory-notes.html
