Favored Fractions

by Lorelei Stevens, President
Wall Street Brokers, Inc.
Copyright © 1998 All Rights Reserved

It's not unusual to buy a fraction of a negotiable note. Many good notes are owned by two or more parties, and only one wants to sell.

Should you buy a half of a note? A third of a note? A fourth of a note?

The fact is that buying a fraction of a good note can be as sound and rewarding as buying a whole note. You have a few more details to take care of, but owning a properly purchased fraction can be lucrative.

A typical fraction is the note owned by a brother and sister who inherited and sold the family home. They financed the sale themselves and now jointly own the note and each receives half the monthly payments. The brother decides to sell his half of the note, but the sister wants to keep hers. You can buy the brother's half of the note and receive half of the monthly payments. This is a very common and very satisfactory fraction.

The usual sources of fractions are from divorces, dissolved partnerships and heirs of estates. What is the most common number of owners? Ordinarily there are between two and four owners, but there can be more.

In order to buy a satisfactory fraction you have two important steps to take: You need a proper endorsement and you need possession of the original note. Both are essential in order for you to be a "holder" of the negotiable note. Being a "holder" is a legal protection that helps assure your ownership. If you are not a holder, you can never be a "holder in due course," which is the highest protection the law can give your ownership.

So, you need a proper endorsement and you need possession. How do you get these?

A proper endorsement of a negotiable note is much like endorsing a check. It contains the statement "for value received, pay to the order of [non-selling owners and you] without recourse," and is signed and dated by all owners of the note. The endorsement is usually written on the back of the note or on a separate piece of paper (called an "allonge") that has been attached to the note so that it becomes a permanent part of it.

When buying a fraction of a note, it is not sufficient to simply get the endorsement of the person who is selling the fraction to you. You must also get the endorsement of all other owners of the note. The others are not selling you their fractions, they are formally negotiating the change in ownership of your fraction and endorsing the note to themselves as well as you. Their knowledge, approval and participation is essential to the negotiability of the note.

All the old owners must endorse the note over to all the new owners.

If you simply accept the endorsement of the person selling the fraction, the negotiability of the note will be permanently destroyed. The reason is the law requires that an endorsement, in order to be effective as a "negotiation," must transfer the entire note. A single endorsement by one owner only transfers part of the note. The result is a "partial assignment" rather than a "negotiation." Once that has happened to a note, it can never be negotiated again, which makes it less valuable. With only a partial assignment, you can never be a holder, which denies you valuable legal protections. So it is essential that all owners endorse the note.

Getting the other owners to cooperate in endorsing the note is easy when you point out that it is for the protection of all owners of the note.

Endorsements should be "without recourse" in all fraction sales. This means that no owner is guaranteeing the note if it defaults. If you want a guarantee against default, you should make a separate agreement with the seller of the fraction. The other owners are not receiving money from you and have no motivation to guarantee your purchase.

The other requirement of being a holder of a negotiable note, possession, is complicated in the case of a fraction because there is more than one owner and it is physically impossible for all to have possession.

The best solution to this dilemma is for the owners to agree upon an agent to take possession of the note in trust, so they can all be holders. The agent can be a neutral third party such as a bank or lawyer, or, if agreeable, one of the owners. But there must be an agreement in writing appointing this agent. The agreement can contain any further details--such things as rights and obligations--that the owners may desire.

Again, the other owners of the note will cooperate in appointing an agent when they realize their legal position about possession is being protected.

By following these few simple extra steps, you can buy favored fractions and prosper.

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