Promissory notes are commonly used in both business and consumer debt transactions. They are typically used when a borrower seeks a loan of significant size, because they offer several advantages to lenders including the ability to sell the note to third parties. Both lenders and borrowers need to carefully consider whether the debt undertaken will be with or without recourse.
Definition of Promissory Note
A promissory is an unconditional promise to pay to the lender, or a subsequent holder of the promissory note, the principal amount of the note, with or without interest, by a certain stated date or on the demand of the lender or subsequent holder of the note. A promissory note can be secured or unsecured. It may also be recourse or non-recourse.
Secured Promissory Note
It is not uncommon that a lender requires the borrower to give something other than a mere promise to pay back the money loaned. Often, the lender requires that the borrower offer collateral to secure payment of the loan. A promissory note where payment is secured by collateral is called a secured promissory note. If a promissory note is not secured by collateral, it is an unsecured promissory note.
Definition of Non-Recourse Promissory Note
A non-recourse promissory note is a promissory note that prohibits the lender from seeking a deficiency payment from the borrower personally if the borrower defaults and the collateral securing the note is insufficient to satisfy the balance due. If a promissory note does not include a "no recourse" provision, then the lender or subsequent holder of the note can pursue not only the property securing the note, but also pursue the borrower personally for payment.
A common transaction involving non-recourse debt is a residential home loan. The borrower makes a promissory note, promising to pay back the loan principal plus interest, usually on an amortized monthly basis. Additionally, the borrower gives the lender a mortgage on the property being financed, which gives the lender a security interest in the property. If the promissory note is non-recourse and the borrower defaults, the lender may seek payment through the property only and may not pursue the borrower personally.
Shawn M. Grimsley holds a bachelor's degree in political science, master's degree in public administration and a Juris Doctor. He practiced law for 10 years, focusing on general business law, securities law, real estate and civil litigation. Grimsley now serves as a teacher and writer.