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A promissory note is a written promise to pay a specified amount of money with, or without, interest at a stated time or on demand. The main purpose of a promissory note is to serve as written evidence of the amount loaned, the interest rate, if any, and the terms under which the loan is to be repaid. Having a written instrument that sets forth the terms under which money is being loaned and borrowed can alleviate misunderstandings and disagreements when it comes time to repay the loan. If a disagreement later arises, as they often do when money is involved, both the lender and borrower will have the promissory note to resolve such misunderstandings.
California Civil Code §1624(a) may also require certain loans to be in writing. Pursuant to California Civil Code §1624(a) contracts that cannot be performed within a year, or involve the sales of goods in excess of $500 must be in writing.
Interest Rate and Usury.
The Internal Revenue Service (IRS), if it learns about your interest-free loan, can "impute" interest on the loan. In other words, the IRS will assume you have earned interest on the "interest-free" loan and in turn require you to report it as taxable income. For most individual loans, however, there is an out. The imputed, but uncharged, interest can be treated (or reclassified) as a tax-free gift if the total amount given to the borrower is less than the annual gift-tax exclusion (presently $13,000).
When trying to determine a fair interest rate to charge, it is important not to run afoul of California's usury laws. Usury is defined as the charging of excessive interest on a loan. Many states have usury laws that cap the rate of interest an individual and private lender can charge for loans. Pursuant to California law, the maximum interest rate an individual may charge on a loan primarily for personal, family or household purposes is 10% per year on the unpaid balance owed.
The maximum interest rate an individual can charge for a loan to be used primarily for home improvement, home purchase, or for business purposes, is the higher of 10% or the amount charged by the Federal Reserve Bank of San Francisco on advances to member banks on the 25th day of the month before the loan is made plus 5%. Because the discount rate charged by the Bank of San Francisco has been extremely low, the maximum interest rate allowed is still just 10%.
Well, you may be wondering how your credit card company can charge you 33% interest. California’s usury laws do not apply to most lending institutions such as banks, credit unions, finance companies, pawn brokers, etc. In fact, in California, there is no limit on how much interest a credit card company can charge. In addition, there is also no limit on how much a credit card company can charge for: late fees, cash advances, transaction fees, stop payment fees, or ATM fees.
Most promissory notes, like an I.O.U., say, "I promise to pay you $_____, plus interest of ___%" and then describe how and when the borrower is to make payments. For a promissory note to serve its purpose, the note should specify the following:
There any many different types of repayments schedules. Repayment may be due "on demand," typically after a specified date. Repayment may be due on or before a specified date. Or, repayment may be due pursuant to a schedule of weekly or monthly payments.
If the borrower fails to repay the loan on time, then what? Is there a higher interest rate the borrower will be forced to pay? Will the borrower be responsible for any attorney’s fees or costs you incur trying to collect?
If someone fails to pay a promissory note on time, the first step is to obtain a judgment against the person for the total amount owed. To do this, you will need to file a lawsuit in either Small Claims Court or Superior Court (in California the maximum recovery in small claims is $5000). If you claim belongs in the Small Claims Court, you should obtain the Complaint form from the local Small Claims Court where the debtor resides, fill it out and file it. A hearing will be scheduled where both sides can present their case. If the court finds in your favor, a judgment will be issued for the amount of note plus interest and costs. If the Note was secured (meaning there was collateral mentioned), in your Complaint you may ask the court to seize the security until the note is paid in full.
Assuming the court renders a verdict in your favor, and assuming there is no collateral, the person still may refuse to pay. If this happens, you will need to institute another action to either seize property, garnish wages, or ask court to order a payment plan. Often times you can obtain a judgment stating John Doe owes you money, however, if John Doe has no assets (real estate, bank accounts) to seize and no money to pay, you may not be able to fully recover the money.
If the Promissory Note is for more than is allowed to be collected in Small Claims, you should hire an attorney to bring the lawsuit since the rules in Superior Court are much more complex than in Small Claims.
Don't be fooled by a promissory note's apparent simplicity. It will never cease to amaze me that people will forgo spending a few hundred dollars and risk losing everything. When drafted correctly, a one to two page promissory note can make the difference between a good loan and a bad uncollectible debt.
If you just have a few questions regarding loans, promissory notes, or California usury law, please schedule a low cost telephone consultation for just $99 or $149 by completing Ms. Marsh’s Telephone Consultation Request Form and Melissa Marsh, a licensed California real estate attorney, will call you back at the time you select. If you would like Melissa Marsh to prepare, review, or revise a promissory note, or other loan documentation, please call her at 818-849-5206 to inquire about the fees and costs.
California Business Law attorney, Melissa C. Marsh, is based in Sherman Oaks and West Hollywood, and is available to serve small and midsize businesses throughout Los Angeles County, including: West Hollywood, Miracle Mile, Beverly Hills, Century City, Santa Monica, Burbank, North Hollywood, Valley Village, Toluca Lake, Studio City, Sherman Oaks, Van Nuys, Encino, and Woodland Hills.
© 2009 Melissa C. Marsh. All Rights Reserved.
Disclaimer: The information presented on this web site was prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. The information provided in my articles and alerts should not be relied upon, or used as a substitute for professional legal advice from an attorney you retain to advise or represent you. Your use of this Internet site does not create an attorney- client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited. You may print or email a copy of any information posted on this web site for your own personal, non-commercial, use, but you may not publish any of the articles or posts on this web site without the Express Written Permission of Melissa C. Marsh.
Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.