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The Latest Installment

Why Congress Provided for Monetized Installment Sales

December 10, 2015

 Those of us who are old enough to remember what was happening in 1980 can recall all too well the state of the economy then:  high inflation, high interest rates, and high unemployment.  We remember the “misery index” which was created by economist Arthur Okun:  the sum of the inflation rate and the unemployment rate.

It was the high interest rates, though, that did the most to bring institutional lending for the buying and selling of real estate and other capital assets nearly to a halt—and Congress heard from the people about it.

Part of Congress’ response was the 1980 codification of what came to be termed the monetized installment sale provisions in the tax code.  Congress saw installment sales as a potentially substantial contribution to economic recovery, because a particular seller who could “carry the paper” on a sale and a particular buyer who needed financing to be able to buy could agree on any interest rate they might choose, regardless what market interest rates were at banks and other financial institutions.

So, to encourage sellers to be willing to carry the paper so that someone could afford to buy, Congress added provisions which allow sellers to sell on installment contracts but receive borrowed money in hand at the same time, without losing the tax deferral that typically accompanies an installment sale.  Under these new provisions, sellers could defer the tax on the sale but have liquidity at the same time.

The rules which Congress put into place allow sellers of agricultural properties and homes to sell on installment contracts and at the same time borrow money, with the loan being secured by the installment contract.  In the case of installment sales of business or investment property, Congress said that the installment seller could enjoy tax deferral and still borrow money elsewhere at the same time, as long as the loan which the seller takes out is not “directly secured” by the installment contract or the lender does not take the installment obligation in satisfaction of part or all of the loan to the seller.

After Congress acted, most people didn’t hear much about monetized installment sales, because it turned out to be harder to arrange for monetization loans than Congress had thought it would be.  While there may have been hundreds or thousands of instances in which particular installment sellers borrowed money at the same time as their installment sales, as far as we know S.Crow Collateral Corp. is the first one to succeed in establishing a relationship with a lender for the lender regularly to offer monetization loans to installment sellers.

What it took to achieve this was for the lender to perceive how to shift from typical asset-based lending to financial risk-management lending—a lending model more like the corporate debenture bond market, in which the purchasers of those bonds (i.e., the lenders) obtain priority of payment rather than security of payment, but with opportunity to hedge their risk financially in a variety of ways.  (Indeed, what drives monetized installment sales is the lender’s pursuit of a higher risk-adjusted return on the monetization loan, not the seller’s tax benefit on the installment sale.)

The monetization lender to S.Crow Collateral Corp.’s sellers receives no security for the monetization loan, either directly or indirectly, from anyone; receives no rights whatever in the installment contract; does not accept the installment obligation in satisfaction of all or any part of the debt on the monetization loan; and has no right or ability to enforce the installment contract or to sue anyone if it’s breached.  That means that the loan is completely unsecured, so that, in our view, even installment sellers of business or investment assets can take out monetization loans without losing their tax deferral.

What the monetization lender obtains instead is priority, in the sense that the money which S.Crow Collateral Corp. pays to the installment seller is supposed to be paid by the seller to the monetization lender.  If the seller actually does so, the monetization lender’s enforcement rights on the monetization loan are limited to that amount of money which S.Crow Collateral Corp. actually pays to the installment seller as principal or interest—but if S.Crow Collateral Corp. doesn’t pay, the lender cannot require the borrower on the monetization loan to make up the difference.  Even as to the money which S.Crow Collateral Corp. pays to the installment seller, the monetization lender is completely unsecured and so is at risk that other creditors of the seller might collect first.

Congress has reiterated, again and again, the high importance which it places on installment sales, their many benefits, and their role in promoting economic growth.  Those factors are as true today as they were in 1980.

Whether to do any of this is a free choice for the installment seller; the seller is free to enter into the installment contract without taking the monetization loan, and the seller is free to apply for a monetization loan without selling to S.Crow Collateral Corp.  In short, the seller is free to do what makes good business sense for the seller: one or the other, both, or neither.

That reminds me to say what I hope is always obvious:  Do what makes business sense for you.  If a monetized installment sale makes business sense for you, clear it with your tax and legal advisers before you proceed.  Don’t rely on my opinion, because S.Crow Collateral Corp. would be across the table from you if we do a deal, not on your side of the table.  When you’re ready, though, we’ll be glad to come to the table.—Stan Crow 

Stanley Crow, our Editor

The Latest Installment addresses situations, questions and issues which are brought to us in the course of the consideration, negotiation or execution of transactions. We don't use the real names of parties to transactions, and we may edit the statement of the question to try to tell the story better. Please feel free to comment, or to take issue, or to raise your own question or situation. If you do the latter, please do not relate any confidential information.

The Latest Installment blog is edited by Stanley D. Crow, who is president of S.Crow Collateral Corp.

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