Protecting Sellers of Partials

A Partial is a part of a note. The way note buyers obtain a part of a note is to buy some of the payments while the note seller keeps the rights to the rest. 

Many note buyers do this, but it is a questionable practice. Partials are highly vulnerable to losses because there is no perfect way to document note sellers’ rights to get the money. 

In a typical partial transaction, the note buyer takes possession and endorsement of the note, and a full assignment of the lien (deed of trust or mortgage). An unrecorded side agreement outlines the terms and conditions of the note seller’s rights to future income from the note. 

Because this gives the appearance that the note buyer bought the entire note, it could put note sellers in an unsatisfactory position because they don’t have possession of the note or any recorded interest in the security—just a side agreement. This could be devastating in the event that the note buyer goes broke. That’s a possibility few in the note industry have ever considered, because note buyers come up with large sums of cash and some are even large financial institutions. But in today’s economy, even the biggest can go bankrupt. 

If a note buyer goes broke, the bankruptcy court has power over the note buyer’s assets, including the amount the note seller is supposed to get in the future. 

How might bankruptcy court look at the note seller’s rights to future money? It could easily conclude that the note seller is just an unsecured creditor along with everyone else and has no specific right to obtain payment. Why? The note seller has no possession of the note! The note seller might not ever get any more money out of the note! 

If the note seller is financially damaged by such a bankruptcy, he or she might challenge it in court, or file a lawsuit against the note broker, if one was involved in the transaction. Either could result in case law or publicity that could hurt the ability of people to broker, buy and sell partials. 

What are some things your attorney could put into your Partial Agreement that might prevent the bankruptcy court from determining that the note seller is an unsecured creditor? 

There are several different approaches your lawyer might take in documenting Partial Agreements so the note seller’s rights are protected:

1.       Appointing a neutral third party escrow to hold possession of the note on behalf of the note buyer and the note seller as a dual agent, with specific instructions signed by both the note buyer and the note seller as to how note funds will be disbursed and what future documents will be signed.  

2.       Recording your Partial Agreement or recording a notification that one exists. NOTATION: Using this approach only could be useless in protecting the note seller. The security normally follows the possessor of the note. 

3.       Language in the Partial Agreement about the note buyer holding the note and its proceeds in some kind of a constructive trust for the note seller. 

4.       Filing a U.C.C. (Uniform Commercial Code) financing statement against the proceeds of the note showing the note buyer as the debtor and the note seller as the creditor, and remembering to re-new it before it expires.

While these steps might help protect the note seller, they could conflict with clauses in your Partial Agreement intended to protect the note buyer.  It’s not a perfect science.

RETURN TO LORELEI'S LIBRARY TOP PAGE