Is Note Carry-Back a Security?

Question

If I buy a property, sell it on terms and decide to sell the note 100% I know I am selling an asset. If I hold back say 20% of that same note, is that considered a security? I heard the idea this morning and the first thing I thought is this is a security. Thoughts?

Bill Gulley · Answer

As to that. I have done the same thing to leverage other deals, I don't see a problem from what you have said.

A good trust attorney should be somewhat familiar with these issues, as securities attorneys are hard to find and are big $$$$.

Another suggestion is go to your state finance department. Ask for the legal dept. See if you can get a reading on the phone. I would send a letter to mine and include all the particulars as to what I was doing, not proposed (big difference because they will respond to doing rather than thinking of it) and ask for a letter of determination of complaince. Then you have their blessing in writing!!!! Good luck...

Bill Gulley · Answer

Kevin, are you saying selling a partial interest of the note? As an asset, your 20% of book is an asset, the market value of you 20%, IMO, will be very slim.

If by security, you are refferring to SEC requirements, it could be, depending on how the note was funded, ie. with a pool of investors, whereby the note is considered a security, selling it will be considered selling a security. If the asset did not fall under SEC Regs, it's not. The fact that only part of the interest is sold or say the cash flow from the asset generally does not consitute a security in itself.  Years ago, I had this conversation with an FBI Agent and between the two of us, we came to conclusion that the way I had structured the transaction, it was not a security.

However, I can also see that any new "partner", as holders in due course, may change the definition. If you are "selling" to a group of investors that are subject to SEC requirements, your holding and asset with them might change the flavor of the asset as now, you may be viewed as an investor with that group. This depends on how the note was sold and the language in your contract, how proceeds are shared.

If you sell, say with recourse the first 80% of the principal amount owing, you will retain an interest in the 80% as you are still on the hook. If you are selling without recourse, you transfer all your interest and have a subordinate position, you might be seen as being in a partnership or investor in the whole obligation. How you structure your sale may have an impact on your note then being viewed as a security from that respect. IMO

That simply can't be answered without all the particulars. I will also say that I have never seen a partial sale being subject to SEC before, but my experience was with corporate or institutional, registered entities. I sold notes to individuals, brought in investors (individually) on an existing note, but never to a group of investors that would tip the scale to require SEC issues. Anyway, who you are seeling to may have an impact on the issue.

If you are concerned, I'd suggest to speak to your attorney, I have no idea what you're contemplating...

Bryan Hancock · Answer

If you sell a note you are selling BOTH a security AND an asset.  The note is a security...regardless of whether or not the SEC or state securities regulators get hot under the collar about it.

My understanding is that selling something you own solely is okay as long as it is done from your own account.  If you slice something up and retain partial ownership and then sell the rest you are selling securities.  I didn't read the whole thread, but it seems like this is what you are doing.  This is still being done from your own account so it seems like it would be okay unless you divide it up a number of ways and start selling small units to many investors.

I agree that dividing the note up into a few pieces and retaining the 2nd is a viable strategy.  I know some folks that do this.  The 1st note should fetch a pretty good price if there is sufficient security interest for the purchaser.

Bill Gulley · Answer

You might look into a Partitioned Note. It's one note but with two or more parts of principal, written as several notes withing the standard covenants of one note and secured by one deed of trust. IE.

The note will recite the lender and borrower, the property, and the debt created to be;

A Principal Part of the First Part (PPFP) in the original amount of 100,000 bearing interest at blah blah....

Together with A Principal Part of the Second Part (PPSP) in the original amount of 25,000 bearing interest at the rate of ....

With such principal amounts constituting the Total Principal Amount of 125,000, hereby created and secured by that deed of trust made of even date.....

This sets aside the PPFP for example to be assigned for a number of circumstances or the entire loan can be viewed as one note.

This is handy for investors as you may recite in the LLC capital account that the PPFP shall be credited to John and the PPSP assigned to Fred....

It's great too for estate planning where one beneficiary may get the PPFP and another gets the PPSP.

You can have as many parts as necessary, I had eight in one loan for a trust. It is also under one deed of trust, a first, so that allows any bank to come in with a conventional second or a HELOC with a second DOT.

I have used this approach in several situations and it is battle tested, bankruptcy, estate planning, partnership agreements, assignments, collateral assignments etc.

Just something to consider....

Kevin Kaczmarek · Answer

Bill,

That is a great example! Thanks for the help and thanks for the email on notes. Although finding notes is only 1% of my business, I sure would like it to be more, and soon.

Bill Gulley · Answer

Hmmm, okay, I had somewhat of some inside information not shared as well, so I made that assumption.

In the builder carry back world, notes are sometimes pledged instead of sold for the construction phases and must meet what the lender deems acceptable. After construction the notes are released when financing or sales close paying off the constructide side. The not is then sitting there, to be rolled over again or it can be sliced and diced (I like that Steve). Sometimes, you have to originate your seller financed loan to meet certain standards to borrow against or pledge. Also, if I were a private investor funding the deal originally, I would want the whole note as collateral for funding, after I'm paid off, the contractor still has the note.

But if you can, originally create two notes, knowing you're going to sell off part of the value, it would make life easier as Steve suggested.

Kevin Kaczmarek · Answer

you are both correct. 99% of our business is originating and then brokering the note to investors and entities. At one point we developed a model to split the note in half and have us carry 50% and an investor buy 50% but it was our understanding from CPA's and counsel that if we did that we would be selling a security. When I heard people carrying back 20% today it made me wonder if there was a certain percentage that falls in the security category.

You both made excellent suggestions. Bill I am going to formulate the model and get a ruling on it, and we are going to look into creating two notes to achieve the same thing.  Essentially when we carry back say 20% of a note, we are taking a junior position to the 80% and the purchaser of the property is making 2 separate payments correct?

Steve Babiak · Answer

From Kevin's profile:

So, I believe that Kevin is originating based on that; I wouldn't be surprised if he is also brokering, since I have seen forum posts from his group where they are willing to acquire notes.

Bill Gulley · Answer

Steve, good point if you originate the note, Kevin is in the business as a broker I believe, so if you buy an existing note, you can slice and dice later on, leveraging other notes or what ever.

Steve Babiak · Answer

Why not just create more than one note in the first place, so that there is no need to slice and dice later?

Is Note Carry-Back a Security?

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