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PROMISSORY NOTE AND ITS IMPORTANCE

Under supervision 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 makers 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'Entena, 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 Besanon 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 courserule. 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 wont. 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 loan to you because youre
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
youve 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 note) 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 borrowers 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 borrowers 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 payments 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 nominal value).
Advantages for promissory note holders (goods sellers):

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):

opportunity to temporarily increase current funds by selling a Banks 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 value).
Advantages for promissory note holders (goods sellers):

o
o
o

prompt payment for goods shipped;


promissory note holder presenting the note for accounting provides the bank a document
package similar to the document package required for loan applic ations;
bank accounts promissory 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