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
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:
"What happens if the buyer stops paying
on the note?"
- THE NOTE. The promissory note should include provisions for
grace period, late charges, default interest, and attorney's
- 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.
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
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