Is your promissory note negotiable?
To lend or not to lend? Well if you do at least make sure that your contract will hold up in a court of law.
- In simple terms, what is a promissory note?
- Intent or promise?
- How much is owed?
- When do I have to pay back the debt?
- Are there any other contingencies?
- Who is the note payable to?
- In Summary
About 12 years ago I loaned $13,000 to a friend that needed to borrow money for an ongoing business. I was promised that I would be repaid out of some accounts receivable that were owed to my friend from another business. Unfortunately, in the following weeks, business relations started to deteriorate between my friend and the business owing him money. A meeting was scheduled for my friend and I to meet with this business to discuss my friend being paid at least some of the accounts receivable then owed so that I could be paid as well. At this meeting I was given a check stub that stated that the company "intended to pay me $13,000 in the next 3 weeks". At the time I was totally nieve and accepted the check stub as some kind of good faith promise to pay. Unfortuntately, I never received a penny from the company and realized that the stub I was given was worthless as a legally enforceable document of any kind. The following is meant to be a guide of some simple details that need to be present for an "I owe you" or promissory note to have value and be negotiable in the eyes of the law.
In simple terms, what is a promissory note?
A promissory note, which some like to refer to as an "I owe you", is a form of contract which is created with the intent to specify that someone promises to pay someone else a specific amount on a specified date. It is also created to give the person holding the promissory note the ability to sell the note to someone else if he or she no longer wants to be the debt holder. A promissory note can be very long, as in the case of mortgage contracts and student loans, or it can be quite short as in the case of smaller, more intimate transactions.
Intent or promise?
The first requirement for a promissory note to have value is that the promise to pay has to be unconditional. This means, in my case, that the "intent" to pay written on my check stub was basically worthless. The promise should not be contingent on something else happening either. The note should not say that the bebtor promises to pay as long as he has a job. In sum, the promissory note should include wording that expresses a simple and unconditional promise to pay the amount owing.
How much is owed?
The second requirement for a promissory note to have value is that the amount owing should be specifically stated, or otherwise stated, the amount owed should be specific. It is common and acceptable to have the amount owed based on an interest rate. However, the promissory note should make it so that anyone could calculate how much would be owing on the note at any point in the future. In the case of a note with a variable interest rate, a person should at least be able to determine what will affect the interest rate attached to the amount owed in the note.
When do I have to pay back the debt?
The third requirement for a promissory note to have value is that the note has to state a time when the debt is to be repaid. This means that the note should either be "payable on demand" of the creditor or it should be payable on a specific date. The dates should be detailed for both partial and final payments.
Are there any other contingencies?
The fourth requirement for a promissory note to have value is that the promissory note must not require the person promising payment to perform any act other than paying the money that is specified in the promissory note. Promissory notes should be as clear and unencumbered with other contingencies as possible. Promissory notes deal with the repayment of money, not with agreements to mow someone's lawn.
Who is the note payable to?
The fifth and final basic requirement for a promissory note to have value is that the note must be payable to bearer or to order. This may seem confusing at first but in reality we all do this when we write out a check. In the same way that a check is made out "to the order of" someone, likewise a promissory note should be made out "to the order of" someone. This enables the creditor, the person holding the note, to sell, or negotiate that check to someone else if they no longer want to hold the note. The promissory note can also be made to the creditor, or bearer, however, without "the order to" written on the promissory note the creditor may be inhibited in trying to sell or negotiate the note to someone else.
In summary, in order for a promissory note to have value, it must meet the following five requirements:
1. the promise to pay has to be unconditional.
2. the amount owing should be specifically stated, or otherwise stated, the amount owed should be specific.
3. the note has to state a time when the debt is to be repaid.
4. the promissory note must not require the person promising payment to perform any act other than paying the money that is specified in the promissory note.
5. the note must be payable to bearer or to order.
Additionally, this article is meant to provide a summary of research that I have done in response to a real life experience of mine. It is wise to always seek the advice and assistance of a licensed professional when engaging in any business transaction that can have substantial legal and economic consequences.
Thank you for reading this article, and I hope that it was helpful.