A secured promissory note is a kind of a document that is signed and intended to acknowledge that some money is owed and is to be paid in future. It is secured in that it is backed by collateral which may be sold or confiscated in the event of a default. This note is hence safer than the unsecured one.
What is “Secured Promissory Note”?
A secured promissory note is a document that is drafted with the main aim of proving that an amount of money has been borrowed by one party from another. It also expresses the intention of the borrower to return the money to the creditor at a specified future date. Lastly, it is secured in that it is backed by some guarantee.
Difference between Secured and Unsecured Promissory Note
The secure note differs only slightly from its unsecured counterpart. Below are the three main differences which these two kinds of notes exhibit:
This is by far the most significant difference between these two notes. The secured promissory note is backed by some collateral whose value is equivalent to or more than the amount owed. In case the borrower defaults, the lender has the leeway to confiscate or dispose of the collateral to recover his due.
Most jurisdictions acknowledge and recognize the secured promissory note over and above its unsecured counterpart. In case any disputes touching on this note spills over to the courtroom, chances of a favorable ruling are rife. The unsecured one is only backed by goodwill, nothing more. It is hence riskier to work with.
Generally speaking, The unsecured promissory notes are limited to high net worth individuals or those with excellent credit ratings. That is because such individuals are unlikely to default on their borrowings. The secured ones are universal though and are mandatory for use in almost all jurisdictions.
How to write and what to include?
Section I: Delineate the Scope
Start off by delineating the scope of the promissory note. This simply entails determining the value of the amount to be advanced to the borrower. Closely accompanying this is the nature and the value of the accompanying security.
Section II: Stipulate the Terms of References
Move on now to set out the terms of references that govern the loan agreement. These are the rules and regulations which both parties to the deal shall adhere to while handling the loan borrowed. It includes such issues as payment schedules, the value of each installment, interest levied in the unlikely event of a default, penalties for late payments (if any), and the circumstances which warrant an acceleration.
Section III: Attach the collateral
Remember, it is the collateral that sets the secured promissory note apart from the unsecured counterpart. It is at this third stage that you have to attach the collateral used to back it up. Needless to say, the collateral has to be equal to or even greater in value than the amount advanced in the form of a loan.
Also, the value has to remain constant throughout the repayment period. Most assets have their value depreciate and become less useful in the long run, you know. Give it an in-depth description for the avoidance of doubt.
Section IV: Showcase the Repayment Installments and Dates
Most loans are refunded in installments. At this stage, you should showcase the value of each installment, the entire repayment period and the dates when each installment will have to be executed. Also, include the interests payable on the loan and the specific times when this shall happen.
Section V: Spell out what constitutes a default and the consequences thereof
It is not uncommon for the borrower to default on repaying the loan at least once in a while. You have to spell out exactly what constitutes a default and the consequences of that default. This is the best time to introduce the acceleration clause to safeguard your own interest as a lender.
Step VI: Execute the Note
Having done your all to draft the note, it is now time to execute the same. This basically entails presenting the note to all the parties to the loan agreement for signing and dating. If dealing with business entities, the said entity has to present a representative who will act on its behalf.
Free Secured Promissory Note Templates
Frequently Asked Questions (FAQs)
Q1. Is a promissory note legally binding?
A. The secured promissory note is legally binding. That is because it is backed by collateral which guarantees the recoupment of the amount advanced even in the event of a default. The unsecured promissory note, on the other hand, is largely not binding in a court of law. It has to be notarized and signed by two or more witnesses before the same might hold in a court of law.
Q2. Does a promissory note hold up in court?
A. As stated above, the secured promissory note holds in a court of law. Its unsecured counterpart, however, does not hold. For it to hold, it has to be notarized and signed by two or more witnesses.
Q3. Which law governs the notes?
A. On the whole, promissory notes are governed by the laws where they are entered into. In most cases, this is the same jurisdiction where the lender, not the borrower, resides. In case the note touches on the purchase of some assets, the jurisdiction chosen is that of the place where the asset is located.
NB: In case the parties to the agreement are from different states, the state law applicable should be expressly stated in the document to ward off any ambiguities.
Q4.What happens on late payments or non-payment?
A. Late payments usually attract some penalties. The disputes arising from such payments are mostly sorted out ‘in-house’ though i.e. between the various parties involved. The non-payments though are more serious and will usually spill over to a courtroom or have the borrower listed in the credit bureau.
Yet again, the precise course of action taken is largely at the discretion of the lender. The finer details of these actions are also clearly spelled out in the agreement.
Q5. What makes a promissory note valid?
A. For a promissory note to be deemed valid, it has to incorporate some traits and features. These are duly signed by all parties to the deal, flawless, notarized (if applicable), and written in a company’s official letterhead.