In today’s Freedom Friday blog and email newsletter, I want to answer a basic question that I am not frequently asked about, but sometimes do get asked about, especially with people who may have done this with a family member, or who drafted this without consulting an attorney, and that is, “How should I handle breach of a promissory note?” A promissory note is a specific type of contract, and there are special considerations in handling a breach. In today’s Freedom Friday blog and email newsletter, I’m talking about how to handle breached promissory notes.
First of all, a promissory note is a specific type of contract between a borrower and a lender (also called a creditor). In a promissory note, a borrower will promise to pay a specific sum of money to the lender (or creditor) either on demand or at a future date (the lender or creditor) has loaned to the borrower that sum of money. Promissory notes are often used for personal loans, in real estate transactions, and in commercial financing arrangements. A promissory note will usually include the amount borrowed, an interest rate, due dates for making payments, and consequences if the borrower defaults on the loan.
Promissory notes can also be secured or not secured by collateral. For example, if you borrow money to buy a house, you will have a promissory note that is secured by a mortgage (wherein the loan for your home is secured by the home itself). Similarly, sometimes when a customer is purchasing a vehicle or a mobile home, the loan is secured by collateral and the collateral is the vehicle or mobile home which was purchased. In some business transactions, the owner of the business may be asked to pledge collateral to secure a loan (the collateral could be the business owner’s home, land, or other collateral).
Breaches of promissory notes can be caused by a lot of problems. Some of these issues include financial hardship or insolvency of the borrower, disputes over the terms of the note, confusion regarding payment schedules, changes in business operations, and fraud or misrepresentation on the part of the lender (or creditor). A major reason why a promissory note is breached is non-payment by the borrower. Here are five (5) steps to handle a breached promissory note:
1. Review the Promissory Note
The first step in handling a breached promissory note is to review the note itself. Read the promissory note carefully and look for payment terms and deadlines, grace periods, penalties, late fees, remedies for breach, and any specified dispute resolution process such as required mediation or arbitration prior to filing a suit. Understanding the promissory note in these areas will help inform you of your next steps.
2. Send Demand
The second step in handling a breached promissory note is to send a written demand letter to the breaching party. The letter needs to explain the breach, cite the relevant terms of the promissory note, demand payment or performance by a certain deadline, and warn the defaulting or breaching party of legal action if the breach is not resolved.
3. Negotiation
The third step in handling a breached promissory note is negotiation, which is usually informal at this stage. This can include negotiating a new payment plan, entering into a partial settlement (the borrower agrees to pay a lesser sum than what was originally owed to settle the breach, and this amount must be paid within a certain number of days), and/or agreeing to modify the terms of the promissory note.
4. Mediation or Arbitration
The fourth step in handling a breached promissory note is to consider mediation or arbitration, especially if informal negotiations did not resolve the dispute. Also, sometimes a promissory note will require the parties to attempt mediation and/or arbitration prior to filing a lawsuit. Mediation is when the parties to a dispute agree to hire a third person (called a mediator) to attempt to resolve the dispute through a formal settlement process of mediation. There is no requirement to settle a dispute through mediation. However, arbitration is usually binding and is a more involved process of dispute resolution. In some cases, arbitration is less expensive than litigation in court, but in other cases, the filing fees are more expensive, although the parties can reach a timelier resolution instead of protracted time in court.
5. File a Lawsuit
The fifth step in handling a breached promissory note is to file a lawsuit and go through the litigation process. In a lawsuit for breach of promissory note because of non-payment by the borrower (this is the most common situation), the lender or creditor must prove that a valid promissory note exists, the borrower failed to comply with the terms of the note (because of non-payment), and money damages occurred as a result. The lender or creditor can not only recover the unpaid principal and interest, but also can recover attorney’s fees, court costs, and both pre-judgment and post-judgment interest at the statutory interest rates.
Thinking about starting a small business? Or maybe your small business is having issues with contracts, leases, business partners, collection issues, or experiencing other barriers to growth? Please contact me at Jonathan@libertylegalok.com to schedule a FREE strategy session.