Fundraising Agreements: Part 9 - Unsecured Promissory Note

An unsecured promissory note is a financial instrument that represents a promise made by a borrower to repay a loan to a lender, without offering any collateral as security for the loan. Unlike secured promissory notes, which are backed by assets such as real estate or personal property, unsecured promissory notes rely solely on the creditworthiness and promise of the borrower to repay the debt. Here's a detailed breakdown of the key aspects of unsecured promissory notes in a legal context:

Definition and Purpose

A. Definition

An unsecured promissory note is a financial instrument that represents a written promise by one party (the issuer or borrower) to pay another party (the payee or lender) a definite sum of money, either on demand or at a specified future date. Unlike secured loans, this type of promissory note does not involve any collateral. That means if the borrower defaults, the lender does not have an automatic right to claim any specific assets of the borrower. The enforceability and the terms of repayment are governed by the contents of the note and applicable law.

B. Purpose

The primary purpose of an unsecured promissory note is to provide a flexible, straightforward means of borrowing and lending money without the complexities and requirements of collateral. This financial instrument relies on the borrower's creditworthiness and reputation for repayment rather than physical assets. It is particularly useful in situations where the parties involved have a mutual trust or in financial markets where the lender is willing to accept the risk of non-repayment without collateral due to the borrower's strong financial background or high credit score.

Unsecured Promissory Note Life Example (not real)

Between: John (Borrower) and Mary (Lender)

Scenario: John needs $5,000 to start a small online business but lacks the collateral to secure a loan. Mary agrees to lend him the money based on his promise to repay.

Unsecured Promissory Note:

Date: February 27, 2024

Principal Amount: $5,000

Interest Rate: 5% per annum

Repayment Terms: John agrees to repay the total amount of $5,250 (principal + interest) to Mary in 12 equal monthly installments of approximately $437.50, starting on March 27, 2024, and ending on February 27, 2025.

Signature: The document is signed by John, acknowledging his obligation to repay the loan to Mary under the agreed terms without any collateral.

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Key Features

1.???? Principal Amount: Specifies the exact amount of money being borrowed, which the borrower agrees to repay to the lender.

2.???? Interest Rate: The rate at which interest will accrue on the outstanding principal amount. This can be a fixed or variable rate, detailed in the note.

3.???? Repayment Terms: Clearly outlines how and when the borrower will repay the loan to the lender, including the schedule for repayments (e.g., monthly installments) and the maturity date by which the loan must be fully repaid.

4.???? Unsecured Nature: Indicates that the promissory note is not backed by collateral. The lender's protection in the event of default relies on legal recourse rather than a claim on specific assets.

5.???? Default Provisions: Detail the actions that can be taken if the borrower fails to make timely payments or breaches other terms of the note, such as the immediate acceleration of the debt, making the entire amount due and payable.

6.???? Late Payment Penalties: Specifies any fees or additional interest that will accrue in the event of late payments, adding an incentive for the borrower to make payments on time.

7.???? Prepayment Terms: Conditions under which the borrower can pay off the loan before the maturity date, including whether prepayment is allowed and if any penalties apply.

8.???? Governing Law: States the jurisdiction under which the promissory note is governed, determining how legal issues will be resolved and which state's laws apply in the event of a dispute.

9.???? Signatures: The note must be signed by both the borrower and the lender (or their authorized representatives), making it a legally binding document. The signatures confirm both parties' agreement to and understanding of the terms.

10. Acceleration Clause: This clause allows the lender to demand immediate repayment of the entire outstanding balance, plus any accrued interest and penalties, if the borrower breaches specific terms of the agreement.

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Limitations on Loan Interest Rates

The limitations on loan interest rates in the United States, known as usury laws, vary by state and are designed to prevent excessive interest charges. Here's a summarized breakdown focusing on general aspects, consumer loans, commercial loans, and specific details for Texas, New York, and California:

General Aspects

Usury Laws: Vary by state, setting maximum interest rates to avoid excessive charges.

Factors: Caps depend on loan type, borrower, lender, and purpose.

Federal Preemption: Federal laws may override state usury laws, especially for loans by federally chartered banks.

Consumer Loans

Interest Rate Caps: Typically range from 6% to 24% per annum across states.

Written Contracts: Rates can be higher if agreed in writing.

TILA: Requires disclosure of loan terms, including APR, but doesn't cap rates.

Commercial Loans

Less Stringent Restrictions: Acknowledges businesses' ability to negotiate terms.

State Limits: Some states still impose caps to prevent usurious practices, for example Florida State.

Texas

Personal Loans: Maximum rate generally at 10% unless higher is agreed in writing.

Commercial Loans: Higher rates allowed if documented.

Variable Rates: Permitted under certain conditions.

New York

Civil Usury: Capped at 16% per annum.

Criminal Usury: Capped at 25% per annum.

Licensed Lenders: May be subject to different regulations.

California

General Usury Limit: 10% for personal use or 5% over the Federal Reserve Bank rate for others.

Exemptions: Loans by licensed lenders like banks and credit unions.

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Advantages and Disadvantages

A.??? Advantages for Borrowers: Quick access to funds without the need to pledge assets; flexibility in negotiation of terms due to personal or business relationships.

B.???? Disadvantages for Borrowers: Potentially higher interest rates; legal obligation to repay the debt based on personal creditworthiness.

C.???? Advantages for Lenders: Opportunity to earn higher interest; simpler documentation and processing compared to secured loans.

D.??? Disadvantages for Lenders: Higher risk of loss if the borrower defaults; limited recourse to recover the debt without collateral.

Legal Considerations

A.??? Documentation: Proper documentation is crucial to ensure the enforceability of the note. This includes clear terms about the loan amount, interest rate, repayment schedule, and any other conditions.

B.???? State Laws: Lenders and borrowers should be aware of the state laws that apply to unsecured promissory notes, as these laws can affect the interest rates, enforcement, and other terms of the note.

C.???? Dispute Resolution: The note may include provisions for mediation or arbitration in case of disputes, which can provide a less costly and quicker resolution than court litigation.

The easiest potential Draft of the Unsecured Promissory Note, CONSIDER IT AS AN EDUCATIONAL MATERIAL,?NOT A LEGAL ADVICE??:

Unsecured Promissory Note (NOT a legal advice)

Borrower: John Doe Address: 123 Maple Street, Anytown, Anystate, 12345

Lender: Jane Smith Address: 456 Oak Avenue, Othertown, Otherstate, 67890

Principal Amount: $10,000.00 (Ten thousand dollars and zero cents)

Interest Rate: The annual interest rate on the unpaid principal balance shall be 5%, calculated on a 365-day year basis, commencing on March 27, 2024.

Repayment Terms: The Borrower hereby unconditionally promises to pay to the Lender the principal sum of $10,000.00, together with interest accrued at the annual rate of 5% on the unpaid balance. The full repayment of the principal amount, along with all accrued interest, shall be due and payable on or before February 27, 2025 (the "Maturity Date").

Unsecured Nature: This Note is unsecured. It is not backed by collateral, and the Lenders recourse in the event of default is limited to legal action against the Borrower.

Payment Schedule: The Borrower agrees to repay the total amount due in 12 consecutive, equal monthly installments of $856.07 each. The first installment shall be due on March 27, 2024, with subsequent installments due on the 27th day of each month thereafter, until the full amount owed under this Note is paid in full by the Maturity Date.

Late Payment Penalties: Late payments shall incur a penalty of $50.00 or 5% of the overdue amount (whichever is greater), adding to the debt owed by the Borrower.

Prepayment: The Borrower reserves the right to prepay, at any time and from time to time, any portion of the principal amount outstanding under this Note without incurring any prepayment fees or penalties. Any such prepayment shall first be applied to any unpaid accrued interest and then to the principal amount outstanding.

Default and Remedies: In the event of a default, where the Borrower fails to make any required payment under this Note within 10 days after such payment is due, the Lender shall have the right, without notice to the Borrower, to declare the entire remaining unpaid balance and accrued interest immediately due and payable. The Lender may exercise this right in addition to any other rights and remedies available under law or equity.

Upon default, the Borrower agrees to pay all reasonable attorney's fees and costs of collection incurred by the Lender in enforcing this Note.

Governing Law

This Promissory Note and its enforcement shall be governed by and construed in accordance with the laws of the state of Anystate, without regard to its conflict of laws principles.