You are in for a treat! You are about to learn how an expert law firm transformed the Fair Market Value of a $2 million promissory note into about 30 cents on the dollar–$711,000.00-or less. Let me repeat – a prominent law firm handling a $3,000,00.00 deal did not know how to draft proper documents!
Let me tell you the key details. But, first let me say that I have camouflaged certain geographic facts and information about the actual transaction in order to protect the privacy of the parties. My engagement was to determine the Fair Market Value of the note as of a certain date.
Fair Market Value is legally defined as “the price at which the property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.” U.S. v. Cartwright, 411 US 546 (1973). Reg. Aï¿½ 20.2031-1(b); Reg. Aï¿½ 25.2512
Here are the key facts:
$3,000,00.00 Sale price of the asset.
$ 500,000.00 Cash down payment.
$2,500,000.00 Face amount promissory note carried-back by the seller.
$2,003,000.00 Unpaid principal balance as of appraisal valuation date.
25% annual interest rate; fifteen year loan term; one payment of accrued interest plus 1/15 of the principal per year; eleven annual payments remaining as of the appraisal date.
Payment History: Current, no delinquent balance.
Here are the problems:
Secured by an unusual asset-water rights (Colorado law considers water rights as real property).
Secured by an unapprised asset-no appraisal supporting a $3,000,000.00 transaction.
Borrower is a shell corporation. No financial information or credit history.
25% interest rate is far below the market rate for a private note; 10.00% would not be considered high.
“Without Recourse” to any person.
Note is not a “Negotiable Instrument”. Wording in the note allows the annual payment to be conditional on the amount of water flowing. This violates the Negotiable Instrument requirement. It should be an unconditional promise to pay.
Here are some lessons to be learned:
REMEMBER THIS WAS A PROMINENT WATER RIGHTS LAW FIRM
Most attorneys are not qualified by actual experience to be experts when dealing with promissory notes. A firm or an attorney may have a grand reputation to the general public; but, that reputation may be in a legal field far removed from promissory notes.
Being a prominent water rights firm does not qualify it to assume the responsibilities related to drafting and collateralizing a promissory note transaction.
Being an attorney does not qualify one to determine “market interest rates” for a specific promissory note.
Being an attorney does not qualify one to determine what collateral and how much collateral is needed for a specific promissory note.
There is no formula to figure out the intrinsic value of a promissory note. You have to know the business.