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Promissory Notes

Promissory Note
Promissory Note

A promissory note is a written instrument that documents or records a transaction where money is loaned or owed from one party to another. The terms of the loan, the repayment schedule, the interest rate (if any), where the payments are to be made, etc., are included in the note. The note is signed by the person borrowing the money. The note is then kept by the person lending the money as evidence of the loan and the repayment agreement (with a copy usually provided to the borrower). The term commercial paper includes written instruments (such as promissory notes) or orders (such as checks) to pay money.

Pay to the order of language is sometimes found in promissory notes (e.g., this type of language is seen on personal checks). When this type of language appears in the promissory note (i.e. John Borrower promises to pay to the order of James Lender the sum of … ), the person signing the note (called the maker) is agreeing that he will repay the money to the lender or the person the lender designates to receive the payments. In other words, the lender can loan the money to the borrower and then direct that the borrower repay the loan to the lender or lender’s wife, brother, friend or other person that the lender owes money to. This type of language gives the lender flexibility in designating who will receive the payments on the loan from the borrower.

Contracts for the payment of money, commonly referred to as bills and notes, are governed by the ordinary law of contracts. However, where bills and notes have the quality of being negotiable, they may also be subject to special legislation, embodied in the Uniform Commercial Code, governing such instruments.

A Balloon Note is a Promissory Note that has one large payment (the balloon payment) that is due upon maturity. A balloon note will often have the advantage of a very low interest rate, thus requiring little capital outlay during the life of the loan. The major problem with such a loan is that the borrower needs to be self-disciplined in preparing for the large balloon payment due when the loan matures. Of course refinancing the note upon maturity is always a possibility.

Parties to Commercial Paper

A note has two original parties – the maker and the payee.  A draft or a check has three original parties – the drawer, the drawee, and the payee. 

The maker is the person who writes out and creates a promissory note. If I execute a promissory note to you promising to pay you $100, I am the maker and you are the payee.

The drawer is the person who writes out and creates a draft.  This includes checks. If  I write a check to you for $100, I am the drawer; you are the payee; and my bank is the drawee.

The drawee is the person to whom the draft is addressed and who is ordered to pay the amount of money specified in the draft.  This is a bank in most cases.

The payee is the person named on the face of the paper to receive payment.  On a check stating, “Pay to the order of John Jones,” John Jones is the payee.

The owner of commercial paper who signs the back of the paper is an endorser.  If the check is made payable to the order of John, John may indorse it to Mary to pay a debt that John owes Mary.  In this case, John, as the payee, is now also an endorser.

The person in physical possession of commercial paper that is payable to bearer or (cash) is called a bearer.  A check made payable to the bearer is payable to anyone who presents the check to the bank for payment.  (Example:  Check payable to cash is the same as to bearer.

A holder is a person in possession of commercial paper that is payable either to the order of that person as a payee or endorsee or to bearer.  If I have a check made payable to me from my Employer, I am the holder.  A holder in due course is a holder of commercial paper who is given immunity from certain defenses

A Promissory Note may be assigned in the same manner as any other contract right.

Inside Promissory Notes