Promissory Note

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DEFINITION of 'Promissory Note'

A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on demand or at a specified future date. A promissory note typically contains all the terms pertaining to the indebtedness by the issuer or maker to the note's payee, such as the amount, interest rate, maturity date, date and place of issuance, and issuer's signature. The 1930 international convention that governs promissory notes and bills of exchange also stipulates that the term “promissory note” should be inserted in the body of the instrument and should contain an unconditional promise to pay.

BREAKING DOWN 'Promissory Note'

Promissory notes lie somewhere between the informality of an IOU and the rigidity of a loan contract in terms of their legal enforceability. An IOU merely acknowledges that a debt exists, but does not include a specific promise to pay, as is the case with a promissory note. A loan contract, on the other hand, usually states the lender’s right to recourse – such as foreclosure – in the event of default by the borrower; such provisions are generally absent in a promissory note.

Promissory notes that are unconditional and saleable become negotiable instruments that are extensively used in business transactions in numerous countries.

A promissory note is usually held by the payee. Once the debt has been discharged, it must be canceled by the payee and returned to the issuer.

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