Does issuing a promissory note or bill of exchange as a "Security Note" change its validity conditions?

Entrance

Promissory notes and bills of exchange, which are negotiable instruments, are among the most reliable payment tools in commercial life. These instruments are generally issued as means of payment. However, in practice, especially in transactions based on trust between parties, promissory notes or bills of exchange are sometimes issued as "collateral instruments".

The fundamental question here is: Does issuing a promissory note or bill of exchange "for security purposes" alter its validity conditions? This article will explain the legal nature of issuing negotiable instruments for security purposes, their validity conditions, and the rights and obligations they grant to the parties, through a fictional case study.

1. Legal Nature of Negotiable Instruments

A promissory note is a written undertaking in which the issuer unconditionally agrees to pay a specified sum of money.
A bill of exchange is a written order issued by the drawer to the drawee, requiring the payment of a specific sum to the payee.

Both promissory notes constitute abstract acknowledgments of debt. That is, they are independent of the underlying relationship. Therefore, a reason is not required for the validity of the note.

2. The Concept of a Security Note

A promissory note is a negotiable instrument issued to secure the fulfillment of an obligation arising from a contract or debt relationship.

It differs from its function as a means of payment.
The main purpose is to provide security against the possibility of a party failing to fulfill its obligation.
For example, when an employer takes an advance from an employee, they can obtain a promissory note to be used if the employee fails to repay the debt.

3. Impact on Validity Conditions

3.1. Formal Requirements

The mandatory elements that must be present in a promissory note or bill of exchange (the words "promissory note" or "bill of exchange" in the text, an unconditional promise to pay, the amount, a signature, etc.) are also required when they are issued for security purposes.
The purpose of providing security does not negate the formal validity requirements of the promissory note.

3.2. Security Deposit Information

The promissory note may include the phrases "this is collateral" or "given as security.".
However, this does not remove the status of a negotiable instrument from the register.
It is merely descriptive of the relationship between the parties.

3.3. The Principle of Abstraction

Negotiable instruments are abstract acknowledgments of debt. This means that the validity of the instrument does not necessarily require the existence of an underlying debt relationship.

Therefore, a promissory note or bill of exchange issued for security purposes is also valid.
However, in this case, the debtor can prove the purpose for which the promissory note was issued.

4. Legal Consequences of a Security Bond

4.1. From the Debtor's Perspective

The debtor provides security to the creditor at the time of issuing the promissory note.
If the principal debt has been paid or settled, the promissory note becomes invalid.

4.2. From the Creditor's Perspective

The creditor can enforce the promissory note if the principal debt is not paid.
However, if the promissory note is used even though the principal debt has been paid, unjust enrichment becomes a matter of concern.

4.3. Objections and Defenses

The debtor may raise the following defenses against the promissory note:

The principal debt has been paid.
The promissory note is given solely for security purposes.
Collecting on the promissory note constitutes an abuse of rights.

5. Fictional Event

Case:
Party A issued a promissory note for 100,000 TL to Party B as a guarantee that the work would be completed on time under a subcontracting agreement. The note was marked "guarantee note". Party A fulfilled its contractual obligations on time. Despite this, Party B initiated enforcement proceedings based on the promissory note.

Legal Assessment:

The promissory note is valid because it contains the necessary elements.
However, the promissory note was given as collateral, and the obligation has been fulfilled.
In this case, Party A may object to the enforcement proceedings, arguing that the debt has been extinguished.

Conclusion:
The promissory note is valid, but if used unfairly, the debtor can defend themselves.

6. Problems Encountered in Practice

Failure to include a security clause: If the purpose of the security is not stated on the promissory note, the debtor will have difficulty proving it.
Transfer to third parties: If the promissory note is endorsed, the defenses that can be raised against the debtor by the new holder, if acting in good faith, are limited.
Failure to return the promissory note even after the principal debt has been paid: The debtor faces a second threat of payment.
Abuse in employer-employee relations: Blank promissory notes obtained from employees can be used as collateral and subsequently subjected to unfair legal action.

7. Proposed Solutions

When issuing a promissory note, the annotation "This is a guarantee" must be written on it.
The promissory note should be returned when the principal debt is paid.
Debtors must keep records of payment or performance.
A separate protocol may be drawn up between the parties specifying the purpose for which the promissory note was issued.
In case of dispute, the debtor may object in the enforcement court, arguing that the promissory note is a security note.

8. Conclusion

The fact that a promissory note or bill of exchange is issued as a "security note" does not change its validity conditions. The note retains its character as a negotiable instrument. However:

If it can be proven that the bond was issued for security purposes, the debtor may use this defense.
The promissory note becomes invalid when the principal debt is settled.
If the creditor uses the promissory note unfairly, they are considered to have acted in bad faith and will be held liable.

To prevent problems with promissory notes, clear clauses should be included, and the note must be returned when the principal debt is settled.

Gamze Akbulut, Law Faculty Student

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