Promissory Notes are Different from Contracts
Avoid Confusion-Understand the Difference
Contracts
A contract requires two parties to agree to its terms. The parties must exchange “consideration” (something of value) that binds both of them to perform a duty. Example: I pay you rent in exchange for you making an apartment available to me for living space. A contract needs to have bilateral or mutual consideration. This means both parties have to give something of value to each other in order for a contract to be valid.
Promissory Notes
Promissory notes are a special type of legal document. They are a created by statute (e.g., The Uniform Commercial Code). A note contains a promise to pay a fixed amount of money at a set time. There is no mutual or bilateral exchange of “consideration”. Promissory notes can work in conjunction with other documentation such as mortgages and security agreements which detail additional aspects of the underlying transaction. Example: When used in a real estate transaction, the promissory note covers the promise to repay the amount owed, interest, and maturity date – while the deed of trust or mortgage outlines the other responsibilities of the parties involved more precisely.
Key Terms
Two key legal terms used in the note are “promissor” and “promisee”. A promissor is a person who makes a promise to repay the money; the promisee is the person to whom the promise is made. The promisee is entitled to receive payment from the promissory.
Some notes are drafted that call the individual who promises to pay is the “maker or the borrower”, and the person to whom payment is promised is called the “payee or the holder or the lender”.
Because of these multiple identity options be certain to understand exactly who is to do what when investing in or transacting a note situation.
Promissory Note Basics
Promissory notes are negotiable instruments like checks: a promise by one person (or company) to pay another. They are flexible as to the size of payments, the timing of the payments, the interest rate, and where each payment is to be made. This flexibility makes promissory notes one of the main financial tools of business transactions.
Another name for promissory notes is “commercial paper” or just “paper”, because it is governed by the Uniform Commercial Code. Checks are the commercial paper most people are familiar with.
Key Features
• It can be valid and enforceable, even if written on a cocktail napkin. It must be written; contracts may be verbal.
• It must promise the payment of money, not services.
• It can be proof that a debt exists. If a person fails to pay the debt specified in a note, no other evidence of a breach of contract is necessary to enforce that debt.
• It will be enforced by a court according to its terms— courts (with a few exceptions) will not interpret those terms
UNIFORM COMMERCIAL CODE – BY STATE
Uniform Commercial Code laws are established by each state. Most Uniform Commercial Code transactions involve secured property (mortgages, deeds of trust, liens) financed by a bank or lender with the title to the secured property held by the lender as security until the loan is paid off.
Conclusions
• Promissory Notes are different from contracts
• Understand the key differences
• Match the correct legal document to the job at hand