Seller Financing selling a business explained by bizology business brokers


September 2, 1998

RE: Consequences of taking back a note on sale of business.

Dear Mr. Bennett,

Per your request, I have prepared this memorandum to explain some of the consequences of a seller taking back a note. It is for informational purposes only and is not intended to be legal advice.

As you know, sometimes it is in the seller's best interests to take back a promissory note on the sales of his or her business. For example, financing may not be readily available for the buyer, or taking back a note may allow the seller to receive a more favorable price. Also, taking back a note may allow the seller to spread out his taxable gain from the sale.

Most sellers fear the consequences of their buyer defaulting on the note. For this reason, certain protection should be given to the seller at closing:

  • THE NOTE. The promissory note should include provisions for grace period, late charges, default interest, and attorney's fees.
  • PERSONAL GUARANTEES. If the buyer of the business is a corporation or limited liability company, the note must be personally guaranteed by the buyer and spouse, if the buyer is married. The reason for this is that the seller may have to sue the buyer personally (for example, where the collateral is no longer sufficient to cover the amount due to seller). In such case, the seller will be seeking a personal judgment for the amount due that can be satisfied from the buyer's personal assets. Most married couples hold their assets jointly and, if the buyer is married, unless the judgment is also against the spouse, the seller will not be able to collect on his judgment.
  • THE SECURITY AGREEMENT. The note must be secured by adequate collateral. The document used for this purpose is called a "Security Agreement" and is similar to a mortgage on real estate. Of course, if the business includes real estate, then the note would be secured by the security agreement on the personal property and a mortgage on the real estate. A Security Agreement provides for enforcement of the seller's rights against the collateral if the buyer defaults on the note.
  • THE COLLATERAL. Usually, the collateral is limited to the assets of the business. The collateral must be listed in the security agreement, and, depending upon the nature of the assets, the seller's security interest (lien) must be "perfected" in each asset. In a sense, this means that the seller's rights must be registered in such a manner to assure him that his security interest is superior to all others who may claim an interest in the same collateral (judgment creditor, taxing authority, trustee in bankruptcy, etc.). Perfection of a security interest in a business is more complicated than filing a mortgage at the courthouse. How and where to file documents is based upon numerous state and federal laws, and it always depends upon the type of collateral. In addition to the inventory and equipment, the assets may include a lease, name, trademarks, copyrights, patents, liquor and other licenses, telephone numbers, advertising, contracts and motor vehicles to name a few. Perfection of the seller's security interest in these different types of assets must be handled by an attorney familiar with such matters.

"What happens if the buyer stops paying on the note?"

The seller should immediately consult with an attorney familiar with enforcement of security agreements (and mortgages, if real estate is involved). Attorney's fees should be reimbursed to the seller in any legal proceedings.

There are a number of procedures, but they all must be done under the advice of an attorney, even those procedures that do not involve going to court. Some of the procedures are:

  • SELF-HELP REPOSSESSION. The law allows the seller as a secured party to use "self-help" against the buyer, i.e. to repossess assets, provide that this can be done without a breach of the peace. Self-help may work with assets like cars parked in an unlocked area or on the street, but generally all forms of self-help are very risky and expose the seller to substantial personal liability.
  • REPLEVIN. This is a form of repossession by court order. Replevin would allow the seller to obtain possession of the property prior to final judgment. Under one procedure, the seller would have to post a bond after which an order would be issued directing the sheriff to take possession (replevy) the collateral. The benefit is that this can be accomplished within a few days. Under an alternate procedure, the buyer would be given notice of a hearing (a short trial) after which an order may be entered direction the sheriff to replevy the collateral. The latter procedure will take about two weeks to obtain an order, depending on the court calendar and how long it takes to have the defendant served. This type of proceeding does not determine ownership, only who has the superior right to possession. After obtaining possession of the collateral, the seller must still follow additional procedures to sell the property in satisfaction of the debt. On the other hand, the speed of a replevin action may give a seller substantial leverage for settlement. For example, a restaurant or automotive repair business may be worth a lot more than the furniture and equipment, but removal of furniture and equipment would effectively close down the business. This consideration often leads to immediate settlement.
  • FORECLOSURE. As compared to replevin, the foreclosure proceeding is used to have the court determine all ownership and lien rights to the business and its assets. At the end of the proceeding, the business and assets are auctioned by the Court. This type of proceeding is useful if the buyer has tax liens against him that may attach to the assets. A foreclosure takes at least four months to complete. However, the seller can request that the Court appoint a Receiver to take possession of the business and operate it so as to prevent hiding or wasting of assets while the case is proceeding.

Although, these procedures may seem complicated, the good news is that the law provides the seller ("secured party") with several remedies to insure full payment of his note, including collection of all interest, court costs, and attorney's fees from the buyer. The enforcement of the seller's claim is covered by the Uniform Commercial Code (UCC) as adopted in Florida. Under the UCC, the "secured party" is not required to elect among available remedies. He can use as many remedies as necessary to secure full satisfaction of his claim. This combination of remedies allows the secured party and his attorney to determine the best possible solution based upon all of the circumstances.

Quite often the threat of commencement of the legal proceeding is sufficient to train a buyer who arbitrarily does not pay the note or otherwise breaches the security agreement (for example by not maintaining insurance). Therefore, the mere fact that a seller may have to file a lawsuit should not be considered any greater risk than running a business in the first place.

If you have any further question on this or any other aspects of business transactions, feel free to contact me.

Very truly yours,

(signature on file)

Xxxx Xxxxxx
Attorney at Law
Attorneys, if you have something you would like to add, please send it on your letterhead and I will post.
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