A promissory note is a legally binding document that is usually attached to a debt instrument such as a mortgage or car loan. The basic mechanism of a promissory note is to define, at the very least, two parties: a borrower and a lender. Many of the terms and features of the loan to be repaid appear in the promissory note.
In a sense, a promissory note has more enforceability than a simple IOU. This is explicit on the promise made by the borrower to repay the loan and abide by the terms of the note. The lender has some level of civil recourse to enforce the note; however, the loan must conform to statutory requirements. A common mistake made by inexperienced lenders is to run afoul of usury laws, which means that the loan may go over the maximum legal interest rate. For example, a loan in Delaware may not exceed five percent over the Federal Reserve discount rate.
The best advice for parties wishing to enter into a loan contract with a promissory note is to seek the advice of an attorney.
Elements of a Promissory Note
The parties entering the contract created by the promissory note must be clearly identified at the outset, followed by the amount the lender gives to the borrower and how much should be paid.
A pledge of security agreement in the note may include a collateral provision, otherwise it is essentially unsecured. The pledge may also include services to be performed or goods to be tendered in kind in case of default.
The default terms should clearly state what will take place should the borrower fail to repay the loan in the manner that is stipulated in the contract. To this effect, the promissory note must include a schedule of repayment dates.
The application of principal plus interest must conform to statutory requirements. The repayment may be amortized, and it may include a maturity date. The body of the promissory note must include clear language that makes it enforceable, including the option to transfer the note to another party and the legal venue to contest performance or default.
Registering and Recording Promissory Notes
Individuals or business entities that wish to market and sell promissory notes will have to check with the Securities and Exchange Commission (SEC) as to the process of registration and recording. Due diligence must be conducted before a promissory note can be entered in the SEC, and only registered brokers may sell these securities.