Promissory Notes

Though they are very common, many people do not understand what a promissory note is used for, or how to draft one. Because these documents are often subject to specific laws, you need to be sure you know about your notes.

Promissory notes are one of the most common forms of loan documents in use. Though common in real estate or in corporate finance arrangements, these documents can be found in almost any situation where one party agrees to loan money to another.

Promissory notes usually exist between two parties; the “promisor” (the person who agrees to repay the money) and the “lender” (the person who is loaning the money.) Though these documents can be short and simple, they are nonetheless important, and anyone who wants to use them needs to know what to look for. Here are a few tips:

When two (or more) people enter into a promissory note, the lender agrees to give the promisor money. The promisor agrees to repay that money, and the two parties use the note to formalize the agreement. Once the note is properly signed and (usually) notarized, the parties have entered into a contract that can be enforced under the law.

What needs to be included in a promissory note?  There may be different requirements depending on what jurisdiction you are in, but in general a promissory note should contain the following information:

  • Amount:  How much money is being loaned?
  • Interest Rate:  How much interest is being charged? When is it payable? 

  • Security Interests:  Is collateral required? If so, what is it?

  • Default terms:  What happens if the promisor fails to pay? The note should state exactly what happens if the promisor defaults.

Is a promissory note considered a secure or unsecured agreement?Generally, these notes are considered unsecured. Because the lender is giving the money in return for the promisor’s agreement to repay it, no other property is exchanged. In other words, promissory notes do not have to involve collateral or any other security interests. However, the difference between a secured and unsecured promissory note is often just a matter of the dollar amount. Large loans usually require a security agreement while smaller ones generally do not.

What are usury laws?  The term “usury” is used whenever transactions involving interest are created. Depending on where you live, there are usury laws that may limit how much interest one party can charge another, how those rates are expressed, and how increasing or decreasing those rates can be accomplished.

Because these laws are usually very specific, and because violation of usury laws can be a criminal offense, anyone entering into a promissory note needs to be certain of the usury laws in your area. Promissory notes that violate these laws may not only be unenforceable or negate any interest charged, but parties that violate the law may find themselves in violation of a criminal statute.