The most common agreement used in the United States is an agreement to lend and repay money. These are referred to as Promissory Notes. The basic provisions of a Promissory Note pertain to the amount owed, the interest to be charged, the due date for payment of both principle and interest, and the security to be offered for the Note, if any. While verbal obligations may be enforceable under some circumstances, especially for small sums, the law often requires a writing (for any sizable sum and for any guaranty of an obligation by a third party) and the simple Golden Rule of Law, as always, pertains: get it in writing!
This article will briefly describe the basic law of Notes, the issues normally to be confronted, and provide simple forms that the reader may download for his or her own use. We emphasize that none of these forms should be utilized without receiving advice of legal counsel.
PERMISSIBLE INTEREST
The Usury laws apply to the legal amount of interest that the Lender can charge for a Note. The law is complex and has exceptions for loans relating to property, loans of a Bank or similar institution, loans connected to consumer loans, etc, etc. For the average person loaning money, it is safe to assume that the maximum interest that may be charged is ten percent (10%) per annum.
Violation of the usury laws can result in forfeiture of interest and, in some cases, voiding the entire Note obligation. Unless the Note provides for a specific interest, no interest can be charged: there is no "automatic interest" written into a Note, though once a matter is reduced to a judgement, the law provides for ten percent interest on the existing judgement (which is why a Note overdue without interest provided in the Note should be sued upon the moment possible since it will then become an interest paying Note.)
Recall that interest paid on a Note is taxable as ordinary income, but repayment of principle is not.
SECURITY FOR NOTES
"Security" is the legal term for the Borrower pledging to the Lender an asset to secure the obligation. Put simply, it means that if the Borrower fails to pay, the Lender may seize the security (or retain the security) as an offset against the amount owed, usually without having to go to court to obtain a judgement.
The most common form of security is to pledge real property to repay the loan. The two most common ways to pledge real property are a Mortgage and a Deed of Trust, described in separate articles in some detail. The procedures for using and enforcing both Mortgages and Deeds of Trust are quite complex and one must seek advice of legal counsel before seeking to use or enforce either.
Another common form of security is to pledge assets such as business equipment or inventory. For the lender, it is critical to record with the Secretary of State a document known as a UCC-1 (for Uniform Commercial Code Form #1) which describes the assets and creates a priority over other possible claimants to the security (as well as putting them on notice that the security has been pledged already to you.) Concurrent with accepting such security, one should perform a UCC search (UCC-3) to determine if any previously existing UCC-1s have already been filed on the assets in question.
Both Deeds of Trust and UCCs allow there to be numerous parties recorded on the same assets in the priority of their filings. (Thus there can be a second and third and more Deeds of Trusts and the same for UCCs) but one must recall that the first in line must be satisfied entirely before the ones following and the same holds true as one goes "down the line."
In bankruptcy (discussed below) secured creditors are treated differently than unsecured creditors, being allowed in most circumstances to enforce their security interests in bankruptcy court without the unsecured creditors having the right to claim any interest in the assets. Security is thus a tremendous advantage to any creditor.
Mortgages require a very complex foreclosure procedure in Court and are very seldom utilized in California. More common is the Deed of Trust which allows a secured creditor to enforce the Deed of Trust in a nonjudicial enforcement proceeding. The reader is invited to review the article on that subject and to call our office for more details.
BASIC CONTRACT LAW AND PROMISSORY NOTES
Notes are actually just a form of contract and the essential rules of contract apply to Notes. Thus, the Note must be unambiguous, there must be "consideration," the parties must be competent to execute the contract, and all the other requirements imposed upon an agreement under California contract law apply. The reader is invited to read the article on Contracts on our website.
SELF HELP AND STIPULATED JUDGMENTS
As with any contract, assuming the Debtor breaches the Note by nonpayment, the Creditor is obligated to file suit, go to trial, and obtain a verdict. Only then, with a judgment in hand, can the Creditor seek to enforce the Note. Security pledged can allow the Creditor to shortcut this process by foreclosing on a Deed of Trust or assets pledged as discussed in the article on those subjects on this web site.
Creditors sometimes attempt to secure their obligations by obtaining an advance judgement on the amount owed so that in the event of nonpayment, the Creditor can simply file the judgement. These procedures are frowned upon by the Courts and require that various safeguards created to protect the Debtor are adhered to. Assuming a legal action has already been filed, one can enter into a Stipulated Judgement which can provide for payment over time and the entry of the Judgement in the event of nonpayment. If no legal action has already been filed, then the operative document is a Confession of Judgement, but the Courts dislike such documents and require an attorney for the Debtor to normally execute the Confession of Judgement prior to it becoming effective.
"Self-help" is the term given to Creditors simply coming into the Debtor's premises and seizing assets to protect themselves. This is illegal without the Debtor's prior consent (which should be in writing) and actually constitutes a crime absent process of law. (Even if you are owed money, if you take some property or enter the premises to seize assets, and do so without a sheriff enforcing a judgement, then you may be guilty of theft and breaking and entering!) While some creditors are willing to risk the relatively remote chance of criminal prosecution to "seize" assets before other creditors arrive or before the Debtor transfers them to other people, recall that bankruptcy will force the creditor to return the assets, other creditors may sue to have the assets returned-and this office has had some aggressive creditors prosecuted for engaging in precisely that type of action.
BANKRUPTCY
Bankruptcy is a right granted to all citizens and legal entities in the United States and allows the debtor to stop all legal process against the debtor immediately upon filing bankruptcy and from that point forward all creditors must seek relief only under the Bankruptcy Act in federal court. To proceed with an action outside of the Bankruptcy Court to collect a debt after receiving notice of bankruptcy from the bankruptcy court can expose the creditor to severe penalties.
There are quite complex procedures for bankruptcy and for perfecting a claim against the debtor and the reader is advised to consult with counsel upon receiving a notice of bankruptcy. Recall that Chapter 7 is a liquidation bankruptcy in which the debtor is allowed to retain a small portion of his/her/its assets and the remainder is given to the Trustee in Bankruptcy to be parceled out among the creditors, pro rata. Secured creditors may petition the Bankruptcy Court to allow them to seize the secured assets and are treated as a different category than the unsecured creditors-but still must receive permission of the Bankruptcy court to proceed.
Chapter 11 (for business) and 13 (for individuals) also allows the debtor to stop or delay all proceedings against the debtor who will ultimately file a plan for repayment of all or part of the debt. From the creditor's point of view, it has the same effect of stopping or delaying all other collection efforts aside from those within bankruptcy jurisdiction.
The reader is advised to consult the web page articles on bankruptcy and legal counsel before seeking to proceed after receiving a notice in bankruptcy.
BASIC PROMISSORY NOTES
The forms below are the basic promissory notes, with and without security for the reader's information and possible use. We repeat that you should consult with counsel pursuant to your retainer agreement before simply using the form. The forms may be individually downloaded for printing from the Retainer Area Downloads page.
PROMISSORY NOTE
For value received, I,____________________ , promise to pay to ______________ the principal sum of__________ with interest at________ from_________ . The principal sum of____________ shall be paid on or before_______________ .
This Agreement shall be interpreted in accordance with the laws of___________ and may only be altered in writing executed by all parties.
Any and all disputes relating to this Agreement or its breach shall be settled by arbitration, by a single arbitrator, in___________ , California, in accordance with the then-current rules of the American Arbitration Association ("AAA"), and judgment upon the award entered by the Arbitrator may be entered in any Court having jurisdiction hereof. Costs of arbitration, including reasonable attorney's fees incurred in arbitration, as determined by the Arbitrator, together with any reasonable attorney's fees incurred by prevailing Party in Court enforcement of the arbitration award after it is rendered by the Arbitrator, must be paid to the prevailing Party by the Party designated by the Arbitrator or Court. Said arbitration shall be conducted in the English language and the award rendered in United States dollars. Service of the Petition to Confirm Arbitration and written notice of the time and place of hearing on the Petition to Confirm the Award of the Arbitrator shall be complete on personal delivery or the deposit of the Petition and notice in the United States mail. The Arbitrator shall strictly adhere to California law in making his or her decision. The Arbitrator is empowered to grant any remedy or relief available to a party in a court of law in this jurisdiction.
Should one party either dismiss or abandon his/her claim or counterclaim before hearing thereon, the other Party shall be deemed the "prevailing Party" pursuant to this Agreement. Should both Parties receive judgment or award on their respective claims, the Party in whose favor the larger judgment or award is rendered shall be deemed the "prevailing Party" pursuant to this Agreement. The parties understand and agree that arbitration acts as a waiver of the Parties' right to trial by jury.
This Agreement shall be binding on the parties hereto, and on their heirs, executors, administrators, successors, and assignees.
DATED:
_________________________________________
signature
_________________________________________
please print name
The above Note is an unsecured one, a very basic form that is probably not appropriate for any but relatively small sums of money. Note that arbitration is provided. If the sum is under five thousand dollars, it may make sense to avoid arbitration and simply have the Note enforceable in a court of law which has smaller filing fees.
Secured Notes require both the Note and the Security Document, be it the Deed of Trust or the UCC-1.
PROMISSORY NOTE WITH DEED OF TRUST
For value received,______________________________ promise to pay to the principal sum of ______________________, with interest at _____________ from _______________________The principal sum of ______________ dollars shall be paid on or before______________________________ .
This note is secured by a DEED OF TRUST on the property commonly known as_______________________________, California, the legal description which is known as ___________________________________________________________.
This Agreement shall be interpreted in accordance with the laws of California and may only be altered in writing executed by all parties.
Any and all disputes relating to this Agreement or its breach shall be settled by arbitration, by a single arbitrator, in______________ , California, in accordance with the then-current rules of the American Arbitration Association ("AAA"), and judgment upon the award entered by the Arbitrator may be entered in any Court having jurisdiction hereof. Costs of arbitration, including reasonable attorney's fees incurred in arbitration, as determined by the Arbitrator, together with any reasonable attorney's fees incurred by prevailing Party in Court enforcement of the arbitration award after it is rendered by the Arbitrator, must be paid to the prevailing Party by the Party designated by the Arbitrator or Court. Said arbitration shall be conducted in the English language and the award rendered in United States dollars. Service of the Petition to Confirm Arbitration and written notice of the time and place of hearing on the Petition to Confirm the Award of the Arbitrator shall be made in the manner provided herein for all notice. Such service shall be complete on personal delivery or the deposit of the Petition and notice in the United States mail. The Arbitrator shall strictly adhere to California law in making his or her decision. The Arbitrator is empowered to grant any remedy or relief available to a party in a court of law in this jurisdiction.
Should one party either dismiss or abandon his/her claim or counterclaim before hearing thereon, the other Party shall be deemed the "prevailing Party" pursuant to this Agreement. Should both Parties receive judgment or award on their respective claims, the Party in whose favor the larger judgment or award is rendered shall be deemed the "prevailing Party" pursuant to this Agreement. The parties understand and agree that arbitration acts as a waiver of the Parties' right to trial by jury.
This Agreement shall be binding on the parties hereto, and on their heirs, executors, administrators, successors, and assignees.
DATED:
_________________________________________
signature
_________________________________________
please print name
The form above requires a separate Deed of Trust which must be signed before a notary and should be recorded in the county in which the property is located. Again, consult with legal counsel before using a Deed of Trust.