Guide to Understanding
A Promissory Note
A promissory note, also referred to as a note payable in accounting, is a contract detailing the terms of a promise by one party (the maker) to pay a sum of money to the other (the payee). The obligation may arise from the repayment of a loan or from another form of debt. For example, in the sale of a business, the purchase price might be a combination of an immediate cash payment and one or more promissory notes for the balance.
The terms of a note typically include the principal amount, the interest rate if any, and the maturity date. Sometimes there will be provisions concerning the payee's rights in the event of a default, which may include foreclosure of the maker's interest. 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 is often considered a good idea for tax and recordkeeping reasons.
A promissory note differs from an IOU in that the latter is a simple acknowledgement of the existence of a debt owed, whereas a promissory note, as its name implies, contains an affirmative undertaking to pay the amount stated.
In the United States, a promissory note that meets certain conditions is a negotiable instrument governed by Article 3 of the Uniform Commercial Code. Negotiable promissory notes are used extensively in combination with mortgages in the financing of real estate transactions. Other uses of promissory notes include the capitalization of corporate finances through the issuance and transfer of commercial paper.
At various times in history promissory notes have acted as a form of privately issued currency. In many jurisdictions today, bearer negotiable promissory notes are illegal precisely because they can act as an alternative currency. Contrary to this popular belief being perpetuated by the banking community, House Joint Resolution 192 passed by US Congress in 1933, explicitly cites Promissory Notes, Bills of Exchange, Drafts and the like as legal tender in addition to Federal Reserve Notes. However, this right is limited only to those persons acting within the admiralty jurisdiction and not in the statutory jurisdiction. Furthermore, all Scottish banknotes are effectively standardised demand promissory notes, although they are rarely cashed.