Checking Promissory Notes
A medical autopsy was performed to determine the cause of death. Performing a promissory note, or letter of mortgage, autopsy identifies errors and omissions made. The person who performs the examination and autopsy on the record is the appraiser. Its task is to evaluate the main valuation factors and determine the value of banknotes.
Fact
A farmer sells rights to water to the municipality for $3,000.00. He was paid $500,000.00 in cash and brought back a promissory note of $2,500,000.00 secured by the Deed of Trust’s first position on water rights. State law considers the right to water as real property. The interest rate on the note is 4.25% per annum; its duration is fifteen years; one payment per year consists of accrued interest plus 1/15 of principal.
The farmer has died; inheritance, including records must be of value for real tax purposes
Fair Market Value Appraisal
The Internal Revenue Service requires estate assets to be valued and valued at “Fair Market Value”; FMV is defined as: “the price at which a property will change hands between a hypothetical willing buyer and a hypothetical willing seller, are not under duress to buy or sell, and both have reasonable knowledge of the relevant facts.” US v. Cartwright, 411 US 546 (1973). Reg. 20.2031-1(b); Reg. 25.2512
At the valuation date, the outstanding balance of the note was $2,0003,000.00; eleven remaining payments; previous payments have been made on time.
Here are the issues that the rater found:
- No collateral security assessment (water rights) is presented.
- The borrower signing the promissory note is a shell company—an “assetless” company.
- The borrower does not provide financial information, financial statements, or credit history.
- The 4.25% annual interest rate on the banknote is well below the market rate for private notes; 9.0% would not be considered too high.
- The note bears an inscription stating “No Recourse” to anyone.
- The words on the note allow the annual payment to be depending on the amount of water flowing.
- An unlimited number of payments may be missed due to insufficient running water.
- Lender Title Insurance Policy covering the note is not obtained.
- The note is not a “Negotiable Instrument”. The wording of the note allows for annual payments depending on the amount of water flowing. This violates the terms of the Negotiable Instruments. It should be an unconditional promise to pay.
Summary — Lessons learned:
The attorney who compiled the record did not have the necessary training and expertise to properly perform this engagement. They were highly qualified in other areas of law and enjoyed a good reputation—but, that didn’t help here.
Drafting, drafting, and evaluating promissory notes is a specialty that requires special expertise, not general awareness. Don’t hire a carpenter to install plumbing.
There is no formula or rule of thumb that dictates how to properly draft a promissory note or mortgage—for maximum Fair Market Value. To do it right, you have to know the business.