In the early 1980s our firm considered buying a risky note from a Mr. Baxter. The risk came from the property that secured the note, which was not up to our standards. We felt the only way to protect our money was to have Mr. Baxter sell us the note “with recourse.”
What “with recourse” means
“With recourse” means that if the payor defaults, the note seller will step in and pay. Mr. Baxter agreed, but a legal question came up: if a note seller sells us a note with recourse, does the law consider that a loan from us to the note seller?
It might be considered a loan, because the note seller has the final liability for paying us back. And if it was a loan, and our yield on the note was higher than our state’s usury laws allowed, would we in effect be charging illegal interest?
What our lawyer told us
Since our yield would be higher than our state’s usury limit, we asked our lawyer. He searched the law and told us there was no case law on the subject in Washington State. In his opinion, though, it was obvious that buying a note guaranteed by the note seller was not a loan, so our yield by definition could not be usury. He wrote to us:
“The holder of the note who sells same and who is obligated on recourse is subject to a portion of the Uniform Commercial Code, which states the endorser ‘will pay the instrument according to its tenor at the time of his endorsement to the holder, or to any subsequent endorser who takes it up.’ Thus, it appears that the endorser’s debt would be that shown on the face amount of the Note. Usury applies only to loans. Sale of a note at discount, assuming a bona fide sale, cannot, therefore, be usury by definition.”
So we quit worrying and bought the note from Mr. Baxter. We even wrote a safety clause into the documents: “SALE: It is understood and agreed that this transaction is not a loan.” Mr. Baxter also clearly knew he had to pay us if the payor didn’t. We had no reason to believe there was any legal problem.
How the case went through the courts
The payor paid for about two years, then the payments stopped. We asked Mr. Baxter to pay. He refused and sued us for usury, claiming that his sale of the note with recourse was really a loan of money from us to him, and that we had charged him an illegal rate of interest.
We hired a lawyer who was expert in litigation and usury, and we felt confident Mr. Baxter’s claims would not stand up in court. The case went to trial. Mr. Baxter claimed to be a borrower; we argued that he was not. We won! The trial court found no subterfuge or scheme on our part to collect usurious interest. We won a judgment against Mr. Baxter for more than $50,000 plus attorney fees and costs.
Mr. Baxter appealed, and the appeal wasn’t decided until 1989. Then the Court of Appeals of the State of Washington reversed the trial court and ruled against us. It awarded Mr. Baxter a judgment against us for nearly $50,000, and canceled the judgment we had won against him. Instead of him owing us money, we now owed him.
We asked the Supreme Court of Washington State to hear the case, but it refused. There was no further appeal, so we paid Mr. Baxter. When we handed the cashier’s check to his lawyers, we were unhappy about the loss but glad to have the case over with.
What we lost
We lost a lot of money on this note:
- The money we were forced to pay Mr. Baxter.
- Our lawyer’s fees and the court costs.
- Part of the money we had originally paid Mr. Baxter for the note.
And Mr. Baxter got the note back from us!
People have asked whether we sued our original lawyer for bad advice. No. He is a friend, and we don’t sue our friends. Besides, many lawyers have since told us they would have given the same advice. Many have also told us that the Baxter appeal decision was a bad one, but that doesn’t change anything about the case.
Lessons about recourse and usury
We learned a hard lesson. When there is no case law on an issue, lawyers can only give their best guess. A substantial part of buying, brokering and selling notes happens in gray areas of the law. This is a tricky and risky business, and not for the fainthearted.
We also learned that making case law is not necessarily a good thing. Case law in Washington State now says that the sale of a note with recourse is subject to the state’s usury laws as between the note seller and the note buyer. Unless there is an exemption, any recourse sale of a note could expose a note buyer to serious usury penalties.
When a note seller offers to guarantee the payments, consult more than one lawyer, especially if you are in a usury-sensitive state. If you don’t want usury worries, avoid having note sellers guarantee notes.
The Washington case is Baxter v. Stevens, 54 Wn. App. 456. See also Western Auto v. Vick, 303 N.C. 30, 277 S.E.2d 360 (1981).
