Real Estate investors in California often work through a licensed Broker, who puts together investor’s cash with potential borrowers. Investors prefer these arrangements (hard-money loans) because they can obtain a higher interest rate for their money, fully secured by a deed of trust recorded against real property. These loans are made through a licensed Broker because broker arranged loans are not subject to usury laws. (More details at the end of this article.) Real Estate Attorneys may be tasked with the job of determining if the usury law applies, and if so, whether this particular loan is usurious. If the loan is usurious, the concern for the investor is to be treated as a holder in due course, free from the defense of usury. It was a bad day for some investors in the Bay Area when the court decided that they were not holders in due course, because the unlicensed Broker kept possession of the notes in order to service them.
In Creative Ventures, LLC v. Jim Ward & Associates, Jim Ward was a licensed real estate broker, and his license was placed with a corporation. He retired and the license expired. He came out of retirement, created a new corporation, JWA, and applied to the DRE to renew his license for the old corporation. Apparently he did not realize that he needed a new license for the new corporation.
A real estate developer borrowed $3 million from JWA. It was through four Promissory Notes, two at 8% interest and two at 10% interest. All the notes included a 6% Broker commission. (For usury purposes, the interest rate is added to the commission, so here they were 14% and 16%, over the 10% usury limit.) This would be ok if JWA was licensed, but it was not. A lawsuit followed.
One of the issues in the decision is whether the investors could be liable for usury. JWA did not indorse the notes to the investors. The investors claimed that the notes were for the benefit JWA and “all assignees of this Note,” and thus they were in constructive possession of the notes. The court said no. An assignment transfers the cause of action or rights in the property, but not transfer of the particular property itself. Thus the investors could not be holders in due course, safe from the usury claim.
Holder in Due Course
Commercial Code 3305(b) provides that a holder in due course takes his or her interest free of many defenses, including the defense of usury. A holder in due course is the “holder of an instrument” who took the instrument for value, in good faith, and without notice “that any party has a defense or claim. To be a holder in due course, one must be a “holder” of the instrument. The “holder” is the “person in possession of a negotiable instrument that is payable either to bearer or, to an identified person that is the person in possession. Investors might have become holders had JWA negotiated the notes by indorsing and transferring possession to Investors. Commercial Code 3201.
The reason for all this is based on the’ law merchant’, not a person but a body of law developed in medieval times to govern transactions between merchants throughout Europe. It was not the law of any state or country, but of the merchants themselves. Under common law contracts could not be transferred so that the transferee could enforce the contract directly. The law of negotiable instruments was developed to allow use of these instruments as evidence of money. The holder may then enforce the instrument in their own name. Such negotiability requires that the transfer may be perfected without notice to the debtor, and that the indorsee may take the instrument as a holder in due course, free from the defenses available to the prior parties between themselves.
Here, the Broker screwed up twice, first in not being properly licensed, and secondly, by holding the notes and not protecting his investors.
A loan is exempt from the usury law if the loan is “made or arranged by any person licensed as a real estate broker by the State of California and secured in whole or in part by liens on real property….” Broker “arranged” loans are those in which the broker acts as an intermediary and causes a loan to be obtained or procured as by structuring the loan as the agent for the lender, setting the interest rate and points to be paid, reviewing the loan and forbearance documents, conducting title searches, or drafting the terms of the loan.