Promissory Notes

A promissory note is a contract. It is a legal and binding promise by a debtor (the promisor) to pay a certain sum of money to a creditor (the promisee) at a future date, usually with interest at a fixed rate. Promissory notes come in the following forms:

• Single-name paper is a note signed by only one promisor.
• Double-name paper is a note signed by two or more promisors or signed by the promisor and endorsed by others. With additional persons standing behind the note, the likelihood of payment is increased.
• A straight note is used for a lump-sum payment. It is the more common instrument, used as evidence of the indebtedness.
• A serial note is used for installment payments. The total amount to be paid is retired by a series of payments, typically of equal amounts and at equally spaced maturity dates. Usually, a serial promissory note contain an acceleration clause that states that in the event of a default in payment on any of the scheduled payments, all subsequent payments become due and payable. Thus, serial promissory notes with stated maturity dates are converted into demand instruments under this provision.

Promissory notes are more commonly used for bank loans than for merchandise transactions. However, some credit executives will ask their customers to sign a note as a way to restructure or formalize a payment schedule on a past due balance. Many credit professionals believe that a signed promissory note will make collection easier.

This practice of converting an accounts receivable into a note receivable not only provides written acknowledgment for the past due debt, but also postpones the due date of the account to the date (or dates) stated on the note. This provides an incentive for the seller to sign the note, and the note itself provides evidence of the existence and the legitimacy of the debt owed by the buyer to the seller. In addition, since a promissory note typically is interest bearing, the creditor can "afford" to carry the debt for a longer period.

Reprinted with the permission of Credit Research Foundation.

Edited by Michael Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.