Promissory Notes: Will Your Form Get You in Trouble?

Many dealers use promissory notes to obligate a customer upon delivery of the vehicle  when the customer wishes to return with his or her own funds or with the proceeds of a loan from a credit union or other lender. Generally, dealers pay little attention to the terms of the promissory note forms that they use which may have been written years ago. That could be a costly mistake in this litigious time.

In general, the provisions of the Truth in Lending Act and Regulation Z (the implementing regulation for TILA)  to an offer or extension of credit when four conditions are met:

  1. credit is offered or extended to a consumer;
  2. the offer and extension of credit are done regularly;
  3. the credit is subject to a finance charge or payable by written agreement in more than four installments; and250_past_due
  4. the credit is primarily for personal, family, or household purposes.

A promissory note is an extension of credit. In a car dealership it’s generally extended to consumers for personal, family, or household purposes by the dealer who regularly extends credit. Therefore, if the note is subject to a finance charge or is payable in more than four installments, the note will be subject to TILA, which requires TILA disclosures. Promissory note forms used by dealers typically do not have TILA disclosures.

How to avoid the problem? When using a promissory note:

  • Do not charge interest which can be considered finance charges under TILA. 
  • Do not charge “fees” in connection with the promissory note that can be considered finance charges. 
  • Do not provide multi-installment payment opportunities. 

Promissory notes should be simple instruments requiring payment of a fixed sum in one installment on a specified date without interest.

And what about dealers who use promissory notes for down payments? These can cause problems under the agreements between dealers and the creditors that accept assignment of the retail installment sales contracts (RISC) dealers’ customers sign.

The agreements between dealers and companies that accept assignment of RISCs generally contain representations and warranties by the dealer with respect to each RISC assigned. And one of the typical representations and warranties is that the dealer received the entire down payment in full from the customer. If the creditor for a deal that goes bad learns of a breach of this representation and warranty because of an open down payment loan when the RISC was assigned, it can claim that the RISC is a recourse instrument and demand that the dealer buy it back. 

So use of a promissory note for a down payment is not a good idea. But if dealer personnel make the mistake of using it for that purpose, they should at least make sure that they collect the full amount of the promissory note before assigning the RISC.