Private LendingOctober 8, 2014
From time to time I’m asked to prepare the documentation for a loan from an individual to a fisherman. Sometimes the proposed loan is from a friend or family member, and sometimes it’s a straight business transaction, uncomplicated by friendship. Either way, it can get complicated.
My approach is pure business. Mom and Dad may out of love want to lend money to their boy, but I’m going to try to make sure they are as well protected as possible. Here are some of the things I do.
First, I make it obvious who I represent. Generally speaking a lawyer can act only for one party to a transaction, so I tell both sides that I represent only the lender. I’m happy to explain the documents to the borrower, but if he wants a lawyer I tell him to hire one – it ain’t me.
I make sure the lender really wants to do the deal. It may be that in fact Mom and Dad are pretty reluctant to make the loan but are feeling pressured. My job may be to play bad cop, to give my clients a safe harbor, to tell sonny that I can’t recommend the loan. I also want to know if it would be a true catastrophe or merely a hardship if the lender lost all the loaned money. If it would be a catastrophe I may not want any part of the deal and I’ll try to talk the lender out of it.
I ask the borrower to produce a credit report. (Anyone can get their own credit report on line.) Very often a private loan is proposed because the borrower’s credit is too poor for a bank to lend. The lender may understand that in general, but a credit report will give us an idea of just how bad the borrower’s credit is. If he or she has numerous judgments, and several recent credit card defaults or similar credit dings, the borrower is probably a candidate for bankruptcy. No matter how good the loan collateral, no lender wants to lend to a person who’s likely to end up in bankruptcy court.
Let’s assume the deal is going to go forward. The foundation of any loan is the written, signed promise to pay, called the promissory note. The note is going to state the terms of the loan: interest rate, repayment schedule, what constitutes loan default, the lender’s remedies in the event of default, and many other important details.
Next comes security, by which I mean co-signors, guarantees and collateral. Co-signors: It is of course possible to lend with just a promissory note signed by the borrower. If the loan is to a married person, the spouse should also sign, because many married couples shift assets toward the spouse who is less exposed to suit or other liability. If the borrower has, say, a prosperous in-law, maybe the in-law signs the note too, if you should be so lucky.
A guarantor generally has the same obligations as the person or persons who signed the promissory note, but the language of the guarantee controls. A guarantee could, for example, limit the guarantee to one-half the loan amount, or provide that the guarantee only kicks in if the lender has unsuccessfully sued the borrower. That aside, there is some very specific law concerning guarantees and if your loan will be guaranteed a lawyer must be involved. And bear in mind that a loan guarantee is one of those species of contracts that is utterly unenforceable unless it is in a signed writing – a verbal guarantee cannot be enforced.
Collateral: Just as your home may secure your promissory note to the bank, so the note should, ideally, be secured by assets that can be sold to pay off the loan balance if there is default. If the loan is for a boat, a “preferred vessel mortgage” should be part of the deal. A preferred vessel mortgage is a creature of federal statute, and in the event the loan goes south it puts the lender ahead of most maritime liens in terms of who gets paid first if the ship is foreclosed upon. (Regular readers of this column will recall that fuel suppliers, insurance companies and anyone else who provides “necessaries” to a ship get an automatic maritime lien on the ship.) Additional collateral can be just about anything: a house, raw land, stocks in a brokerage account, etc. Such a “security interest” must be properly recorded – consult a lawyer.
Collateral is only useful if you know the value and if you know it is unencumbered. If a preferred vessel mortgage will be part of the deal, you will want to see a condition and value survey (“C and V”) that shows that the boat has sufficient value to secure the loan. You will also want to run the title, to make sure no other lender is ahead of you in obtaining the security. That’s what banks do, and so should you.
Remember insurance. If the loan is for a boat, the boat should be insured for both loss of the ship (“hull”) and injury to crew or to others (protection and indemnity, or “P and I”). You should be named a loss payee on the policy “as your interests may appear”, often abbreviated ATIMA. The policy should provide that you get notice if the policy will be cancelled. These are standard endorsements that any agent can handle with a phone call – don’t close without them.
Finally, there is life insurance. The typical commercial fishing operation is a one man band, and if the owner dies, the business goes into immediate crisis, with no income and bills still to pay, including your note. Meanwhile the heirs or the lenders struggle to find a buyer. The boat is set up for the deceased owner. Other fishermen may scratch their heads trying to figure out how certain gear was used. The boat will very often sell for less than the appraised value, perhaps far less. If you are a secured lender, the death of the fisherman-owner may be a financial disaster.
But suppose the borrower has or can get life insurance. He puts you, the lender, on the policy as a loss payee as your interests appear. If the guy should die, you get paid in full and the loan and vessel mortgage is discharged.
Some people reading this will assert that they don’t need to go to all this trouble, because they trust their borrower to do the right thing. Bear in mind, if the borrower is in bankruptcy or deceased, you will be dealing not with your borrower but with a personal representative or a bankruptcy trustee. The PR or trustee will scrutinize your loan and if he or she can defeat the mortgage, or find some other flaw in the lending, they will bury you. This is especially true in the case of bankruptcy trustees, who are trained in doing exactly that. Expect no mercy.
Nicholas Walsh. (207) 772-2191, firstname.lastname@example.org
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