How to Protect a Promissory Note from Creditors

A promissory note is a legally binding agreement in which one party promises to pay another a specified amount, typically in installments, over a set period of time. Business owners sometimes receive promissory notes when selling a business, or individuals may hold them as part of private loans.

But when the noteholder has a judgment entered against them, the payments under the note can become a target for creditors.

How Creditors Reach Promissory Note Payments

If a judgment is entered against a debtor, creditors can garnish payments owed to that debtor.

With a promissory note, this means the creditor can serve a writ of garnishment on the note’s payor. Instead of making monthly payments to the debtor, the payor must send them to the creditor until the judgment is satisfied.

Fair Market Value and the Sale of a Promissory Note

We sometimes advise our clients to protect a promissory note by selling it to a third party.

However, to defend against a fraudulent transfer attack, Florida law requires that the sale of an asset be for reasonably equivalent value. If a debtor sells a note for an amount that is too low, a court may set aside the transfer as a fraudulent transfer intended to hinder creditors.

Determining a fair market value for a note is not straightforward. The value of a promissory note depends on:

• The creditworthiness of the payor.
• The history of timely payments.
• Whether the note is secured or unsecured.
• The interest rate on the note.
• The discounting of future payments to account for the time value of money.

In practice, unsecured notes usually sell for significantly less than their face value. Professional appraisers can determine the fair market value of a note. A sale supported by a credible appraisal is much harder for a creditor to challenge as fraudulent.

Who Can Buy the Note?

The choice of purchaser also matters.

A sale to an unrelated third-party investor is more likely to be respected as a legitimate transaction at fair market value. By contrast, selling the note to a family member or friend invites suspicion.

Protecting Proceeds from the Sale

Selling the note is only part of the solution. Once the note is sold, the debtor receives cash proceeds. Cash sitting in a bank account is easy for creditors to garnish.

To truly protect the value of the note, the debtor must then consider asset protection strategies for the sale proceeds. But this is easier than the note itself. Some options include:

• Converting the proceeds into exempt homestead equity.
• Transferring the cash to an offshore trust.
• Depositing the cash into a protected bank account.