1. Elements of an Enforceable Promissory Note
2. Types of Negotiable Instruments
3. The Concept of Negotiability

Is a promissory note a negotiable instrument? Yes; this type of negotiable instrument can be transferred by its holder just as cash can be transferred. Promissory notes are used for many reasons, such as to create debt between private parties that can be legally enforced and by limited liability company (LLC) members to make capital contributions to the business.

Elements of an Enforceable Promissory Note

A promissory note is not considered legally binding unless it meets all these conditions:

  • No conditions are to be fulfilled prior to payment being made.
  • It must have a written statement in which one party promises to pay the other party a specific sum of money.
  • The principal amount indicated on the note must be static, though the interest amount can be variable. However, it must also be considered reasonable by the court.
  • It must contain the words "pay to the order of" with either the person's name or the term bearer.
  • It must be payable either on demand or within a specific time frame, such as "two weeks after the note is presented for payment."
  • It does not require the indebted individual to act in any way besides making the required payment.
  • It must be payable in money. A promissory note to pay back $1,000 in gold or diamonds is not valid.

Types of Negotiable Instruments

Drafts and notes are the main types of negotiable instruments. While a note is a promise, a draft is an order and must involve three parties. The promissory note only involves two parties, the person who makes the note and the one who pays it. Notes focus on debts while drafts are specifically used only for payments.

Notes represent a bank or private loan in an official way that makes the debt legally enforceable. A promissory note does not simply indicate that a debt exists; it must also indicate the exact amount and terms for repayment.

Common uses of promissory notes include obtaining capital to run a business or borrowing money to finance a real estate purchase. For example, the promissory note for a mortgage would indicate the total loan amount, the interest rate, and the maturation date.

Promissory notes are subject to somewhat stringent government regulations since left unchecked they could constitute private currency. In fact, promissory notes once served exactly that purpose. Paper money is actually a promissory note since it contains a promise that the government bank will pay the bearer of the bill a specific amount. These notes could once be exchanged for gold.

Unlike a promissory note, a draft or check requires three parties: the person who writes the check, the person to whom the check is payable, and the drawee, or the bank, that pays the specified amount when presented with the check.

A time check or draft is payable at a specific time and date. A sight draft is payable when it is accepted. Goods are often sold with trade acceptance, a type of draft that can be sold to a third party to raise money.

A certificate of deposit (CD) is a type of note in which a bank indicates that it has received funds from an individual and promises to repay that amount plus interest on a certain future date. CDs are a good investment because of their high interest rates.

The Concept of Negotiability

A negotiable instrument must be a written document signed by the person who created it. It must contain a promise to pay a certain amount without conditions. This must be an exact amount, with or without interest, that is either payable at a specific future date or on demand to a specific individual. The negotiable instrument gives someone credit or serves as a substitute for money, and must be easy to transfer while remaining collectible.

Checks, bills of exchange, and promissory notes are all considered negotiable instruments because the person who holds these notes can claim payment provided that they are taken:

Because the endorser has the liability of ensuring that a promissory note is in good title, this is a very secure type of negotiable instrument.

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