Promissory Note Enforcement

Promissory notes are often the simplest way to finance the purchase or sale of a business.  As we explained in our October 4, 2012 post, promissory notes are negotiable instruments similar to checks.

But what happens when the person who signed the promissory note (also known as the “maker”) doesn’t pay when he or she promised to?  Unlike checks, promissory notes can’t be cashed or deposited at your bank.  Instead, if the maker doesn’t pay, then the person who holds the promissory note has to exercise his/her legal remedies to enforce it.

The good news is that enforcing a promissory note is relatively simple.  That’s because under the Uniform Commercial Code (“UCC”), a promissory note is proof that a debt exists.  In other words, if a person fails to pay the debt specified in the promissory note, no other evidence of a breach of contract is necessary to enforce that debt.  This is important when you sell a business because you do NOT necessarily need to sue to enforce the whole purchase and sale contact to get your money from your buyer.  Instead, you only need to sue to enforce the promissory note.

The bad news is that to enforce the promissory note you will likely need to sue the maker of that note, get a judgment from the court, then collect on that judgment by means of typical collection remedies (for example, wage or asset garnishments).

When a promissory note is used to finance the purchase or sale of a business, the promissory note is typically “secured.”  This means that the maker grants the holder of the note an interest in inventory, equipment, bank accounts or other assets of the company that was sold.  If the security interest was properly created and a financing statement was filed as required by the UCC and state law (in Colorado, with the Secretary of State’s office), then to enforce the promissory note you can foreclose your lien on the secured property (“collateral”) and take it back.

The keys to easy enforcement of a promissory note are 1) make sure the promissory note is drafted very precisely to comply with the UCC, is dated and signed; and 2) make sure the note is secured by a security interest in easily identifiable collateral, and that the security interest is “perfected”, that is, filed in compliance with state law.

If you have any questions about drafting or enforcing promissory notes or other financing tools for buying or selling a business, please contact David Closson, attorney and the head of our Business Law Group, at [email protected].