What is a Note?
To quote Julie Andrews (Maria) in The Sound of Music, “Let’s start at the very beginning, a very good place to start…” So, our beginning is the question – What is a Note?
Black’s Law Dictionary says this:
Note, n. (17c) 1. — A written promise by one party (the maker) to pay money to another party (the payee) or to bearer. A note is a two-party negotiable instrument, unlike a draft (which is a three-party instrument). Can also be termed “promissory note.”
So, a “note” for the purposes of those who will read this blog is a promissory note, usually one that accompanies a mortgage or a deed of trust. At its base, a note can be as simple as a one-page promise to pay money or it can be a multi-page document riddled with rights and remedies, notice requirements, adjusting interest rates, etc.
In the legal world of lawsuits, motions, briefs, and court orders, the term “note” is something that lawyer-types call a “legal term of art.” You might refer to it as a “loaded term” or a word that means more than its mere definition because of its usage in statutory and case law. So, when we say we “own a note,” in the legal context we’re specifically saying we have the thing that Black’s Law Dictionary described above.
However, it has been my experience working with clients in the note investing community, that some investors, servicers, borrowers, and even other attorneys think that any document evidencing a debt and associated with property is a “note.” Here’s where it can get confusing… they may be right, but they may also be wrong.
For instance, is a home equity line of credit (“HELOC”) a note? YES, insofar as it is a written promise by one party to pay money to another party named in the document. However, the answer is also NO, insofar as a HELOC is not a promissory note and is not a negotiable instrument. (We’ll talk more about negotiable instruments in a later post).
What do the Courts think? For example, a Florida appellate court held that “a promissory note is an unconditional promise to pay a fixed amount of money, and as such, it is a self-authenticating negotiable instrument.” On the other hand, the same court held that, “a HELOC note does not require payment of a fixed sum. Rather, it is a promise to repay draws that may be taken from time to time against a credit limit.”
Demakis v. SunTrust Bank, 312 So. 3d 1015, 1016 (Fla. Dist. Ct. App. 2021).
So, is this all just academic stuff for nerdy lawyers? Not really. It is important for note investors to understand the legal differences between the documents they’re looking at, so they don’t end up buying “notes” that turn out not to be notes. Note investors should consider whether the note they are thinking about buying (or the note they may already own) is a clearly defined note that we’ve outlined above, or something “like a note” such as a HELOC. Note investors should always thoroughly review all of the collateral (loan documents) and pay close attention to the terms of the loan. Knowing the character and nature of the borrower’s payment obligation will go far in evaluating whether or not the document is technically a note. This also makes it easier to predict the loan’s enforceability and determine strategies for foreclosure or enforcement of the loan.
What are the key components of a note? Things to look for include:
Identification of parties
Clear definition of the full amount owed and interest to be charged
Date of payments
Right to assign (transfer the obligation to another)
Signature line
All note endorsements and allonges are kept together with the note (more about this in later articles!)
Ultimately, whether your note is a true “note” effects the amount of work that has to be done to enforce it, and therefore significantly effects your bottom-line profit. Learn the basics and stay updated with the legal side of note investing, and you’ll stay two steps ahead in the note investing game.