The promissory note is a written promise document signed between two parties for fair dealings. It is also called a written promise by one person for another person to earn the trust to pay back the stated amount to the bearer or the specified person on a specified demand or at a specified date.
Purpose of Promissory Note
It is an unconditional promissory formal document signed between the parties. The promissory note is a claim of received money and a promise to pay it back to the lender until a specific time.
3 Components of a Promissory Note
There are 3 components of a promissory note template. However, a promissory note can also be written with just two components that are maker and payee. Sometimes, a third party (bearer of note) can be involved that depends upon the condition.
- Maker: A person that makes the note as a promise is called the maker, debtor, drawer, payer, promisor, issuer and in some cases buyer.
- Payee: The person for which the promissory note is formed is called payee, creditor, drawee, lender, promisee, acceptor, holder and in some cases seller. A payee is a person to whom the money has to repay.
- Endorsee: The third party is called the endorsee. The endorsee will be clearly mentioned in the note. In the case of endorsement, the payee will be endorsee.
In the case of the endorsee, the maker will be bound to pay the sum of money back to the endorsee, not to the promisee.
Promissory Note VS Demand Note
The importance of the promissory notes can be understood by going through its developing history. It is stated that it was first used in China. People used payable notes (Promissory notes) in their dealing in place of money. During that time promissory notes were quite beneficial for the creditors because there was no return specific date mentioned on the promissory note. So, the creditor can demand money from the debtor at any time according to his choice. That is why the promissory note was called “Demand Note”.
Working of Promissory Note: Promissory note as a legal step to get the protection of being deceived by the debtor got its name in the 1930s international convention. Any document to be called a promissory note (pro-note) should abide by the following two conditions:
- The document should contain two words “Promissory note”
- The document should be unconditional
A promissory note is favorable in all situations due to its flexibility. The flexibility of promissory note is guaranteed from the fact that it is free from the severity in case of a loan contract in which penalties exist on the debtor if he/she fails to fulfill the commitment, and casually in case of IOU which does not even specify debt money. So, promissory note has soft corners for the promisee in the context of a contract and for the debtor in the context of the time limit specified in some cases.
Promissory Note Format and Writeup Guidelines
The pro-note must contain the following features in order to be a perfect agreement
- Pro-note should be a written document, not a verbal acceptance.
- There should not exist any condition in it like the money will be paid after this or that: event. The condition is only acceptable in a promissory note when it is for a certain event.
- The drawer name must be clearly mentioned in the note.
- The creditor’s name must be clearly mentioned in the note.
- The promissory note must contain the amount of loan that the debtor took from the lender.
- The issuer must include the statement of settled interest between them.
- The issuer should specify the date of the start/maturity date (depends upon the nature of promissory note) in the promissory note.
- The promissory note should be compulsorily signed by the drawer
- The pro-note must contain the penalties for late payments
- The promissory note must be registered in order to get validity
Promissory Note Types
Basically, a promissory note is of two types given below with detail
- Secured promissory note
- Unsecured promissory note
- Secured promissory note:
If any collateral is highlighted in the promissory note then this pro-note will be called the secured promissory note. Collateral can be an asset of the promisor that he/she offers to the payee in order to ensure their interest in the repayment process. It works as the “loan and interest security” device for the lender.
- Unsecured promissory note:
The opposite of the secured promissory note is the unsecured pro-note. As its names represent, in this note no collateral is mentioned. The lender hands over his/her money without any demand for interest.
When to Use a Promissory Note?
The followings are the various situations in which the maker can issue a promissory note:
#1 On-demand and usance:
The demand promissory note is formed with the requirement that when the creditor demands a given a loan the payer is indebted to repay the money. In the case of a usance promissory note, the debtor is bound to return the loan at the fixed date declared on the promissory note. In the latter case, the lender can not demand a provided loan before that future date.
#2 Payable in installments or lump sum:
In this type of Promissory note, the loan will be repaid in installments or in a single payment.
#3 Interest bearing and interest-free:
In many cases, interest is charged on the loan. In those cases, the issued promissory note is an interest-bearing note. In some cases, depending on the time duration for which the loan has lent for example 2-3 months, the lender is not interested in the interest. In those cases, the issues promissory note will be an interest-free promissory note.
#4 Single or Joint Borrowers:
The promissory note can be signed by the joint borrowers to show their indebtedness to the lender.
#5 Non-negotiable or Negotiable:
A promissory note can be one of these types. If the creditor name, to whom the lump sum is repayable, is clearly given in the note then it is a non-negotiable promissory note. If the creditor puts up the third-party name, to whom the money is repayable then it will be a Non-negotiable promissory note.
#6 Promissory note as business credit:
In the business, the promissory note acts as credit for a company to get financial assistance, for its flourishing business, from any payee or institution. In order to understand this mutualism trend, take an example of a buyer, who wants to purchase some goods from the seller, but he/she does not have money to buy the goods from the seller, but the buyer can use promissory note to ensure the seller that if he/she provides the goods in exchange of this promissory note, then within some time period the buyer will repay the whole money to the seller. In this way, a buyer can take advantage of the promissory note as business credit. Similarly, a seller can develop strong business relations with the buyer for the future.
#7 Promissory Notes in Business:
Many times, the company has to take a loan to buy goods from the seller. The seller prefers the promissory note over long-established resources like bond issues and corporate loans. The reason behind this biasness lies in the fact that the interest associated with the note is beneficial for the seller than the bond. The other reason is that the payee can check either the note is properly registered with the state securities regulators or with the Securities and Exchange Commission to know its validity. With this, the investor can be able to conclude that the company enables enough to repay the loan.
#8 Promissory note as an apt investment:
A promissory note will be regarded as an investment pro-note if it is concerned with the investor or shareholder. In both these cases, the money that is loaned, to any company for business, have to repay the investor or shareholder either the company is making progress or facing economic So, this sort of pro-note carries importance for the payee to reduce like the hood of losing money legally. Not only the benefits mentioned above, but an investor can also avail the opportunity to sell the promissory note to another investor to cement his/her securities.
With the use of pro-note, an investor makes it possible to receive rewards periodically from the company. An investor must take some precautions in order to avoid to buy the fraud promissory note like the investor must check the registration of the promissory note before to buy it.
#9 Promissory Notes for students:
Promissory notes provide assistance not only for the business dealers but also for the students. In case of a study loan from private sources, students have to issue a promissory note. The number of times one student signs for the promissory note depends on the source like in case of the private source, from where a specific sum of money he/she lends, on every taken loan it is compulsory to issue promissory note.
In a case, where the school offers loans to students, the debtor has to sign an agreement once and he/she can take loans with this only one signed promissory note. The schools where “Federal students’ loans” are offered by the U.S. Department of Education, a master promissory note is a reminder to the students for those points he has committed to fulfilling. A master promissory note is not as simple as for business dealers, it contains some specific information like either the students are working in any institute as a permanent or temporary employer or note as well as students’ contact numbers.
#10 Mortgage Promissory Notes:
Here discussed another case where pro-note plays its role. When a person lends some money to own a home, he issues and bounds to follows a mortgage which specifies his repay responsibility. This mortgage also outlined interest rates and possible penalties. The important step of mortgage is to keep its record. But the above-stated mortgage, after the payment of the loan is of no use, that is there is no need to keep its record. It means here, the mortgage is, in reality, a promissory note. A homeowner can also get a mortgage loan through a promissory note. In that case, the lender holds on the mortgage and takes a promissory note from the payer. If the payer fails to give his/her interest rate or penalty the lender has the right to take the house back.
Whenever, there is a dealing related to money where one acts as a money giver and another money taker, a well-known document births called promissory note. The transfer of money from one side to another is based on some events. This event can be a business of any kind. That is why the promissory note is considered to be associated with the business.