Alternatives to the Multi-Lender Rule

by Dennis H. DossChristopher J. DonovanDoss Law, LLP

If a private investor relies on you for any aspect of a trust deed investment, you are engaged in the sale of securities. The only scenario I can imagine that would be otherwise would be when an investor brings the potential loan to you, does his or her own due diligence and collects the loan without your help—a very, very rare thing.

Since you are selling securities, you have to be concerned with three things: (1) disclosure, (2) suitability and (3) compliance with an exemption from registration with the Department of Business Oversight (I will assume the borrower, the property and the investors are all California residents so can rely on the federal intrastate securities exemption). This article will only focus on (3): California exemption compliance.

Before we look at your exemption choices, it is important to keep in mind that the DRE requires you to declare your exemption choice in your written disclosures to your private investors and in your loan file. (Business and Professions Code Section 10236.7). Unfortunately the DRE does not provide any model forms for this purpose so they have created a bit of trap for the unwary. If someone from the DRE is reading this why don’t you take the time to update your 851a, b and c forms? I typically include this information in my Loan Sale and Servicing Agreement.

Another thing to keep in mind that the rules and limitations in Business and Professions Code 10232.3 apply regardless of the exemption you choose. Section 10232.3 is a not a securities rule but rather a rule of substantive law applicable to real estate brokers selling trust deed investments. Among the requirements of 10232.3 are: (a) loan-to-value limitations, (b) special rules and limits on rehabilitation and construction loans, and (c) the requirement that the broker obtain a statement from the investor that the investment does not exceed 10% of the investor’s net worth, excluding home, furnishings and automobiles.

Single Investor

If you are selling the loan to a single investor, you will mark your file and disclose that you are relying on Corp. Code 25100(p). That statute in the California securities laws exempts the sale of a loan to a single private investor through the services of a real estate broker.

If there will be more than one owner or beneficiary of your trust deed investment, there are three most common choices. Each have different requirements. You are required to designate one of them in your investor disclosures and file if there are multiple lenders.  Here are your choices:

Multi-Lender Rule

The Multi-Lender Rule is contained in Business and Professions Code Section 10238. You would designate your file “Multi-Lender Rule—10238”). The primary requirements are:

  • No more than 10 loan owners
  • No out of state collateral property
  • All loan owners must be treated equally
  • The loan must be serviced by a real estate broker using a servicing agreement with special features, such as democracy, no commingling of funds, etc.
  • A Lender/Purchaser Disclosure Statement (RE 851a, b or c, as applicable) must be given to each private investor and signed before the investor’s money is taken for the deal.
  • The broker must declare himself or herself to the DRE an issuer of multi-lender investments by filing a Multi-Lender Notice RE 860 (one time filing). Thereafter the broker must file quarterly trust fund reports.

The benefits of the Multi-Lender Rule is that advertising for capital is permitted. Investors do not have to be “accredited” but you must determine that investment is “suitable” for them. The Investor Questionnaire (RE 870) is gathered for this purpose. When the real estate market turns south (as it always does), you can expect investor attorneys to dissect your suitability analysis to shift losses to you. So, you might want to set high standards about who you take money from.

Corp. Code 25102(f)

When you have to exceed 10 California investors or treat investors within a loan differently, your next best option is Corporations Code Section 25102(f). If you use it you would designate and disclose “Corp. Code 25102(f)”. The primary requirements are:

  • 35 or less California investors
  • No advertising for investors (but you can use email or telephone calls to raise money from existing clients)
  • Investors either have to be sophisticated or have a preexisting relationship of the quality that would give them access to information about the investment. This has to be documented.

A form (LOEN) must be filed with the Department of Business Oversight and a fee paid, but the exemption is not dependent on the filing of a LOEN.  I advise clients to use the Lender/Purchaser Disclosure Statement and a special subscription agreement when relying on 25102(f).

Regulation D—Rule 506

If none of the above exemptions fit or you have either out of state collateral or out of state investors, your last practical choice is SEC Regulation D, Rule 506. It “preempts” state registration laws. If you use this exemption you would designate “Rule 506”) in your file and in your investor disclosures. The primary requirements are:

  • Unlimited number of investors
  • Investors can come from any state but they must be “accredited,” meaning they have an income of at least $200,000 during the past two years ($300,000 if investing as a married couple) OR a net worth exceeding $1,000,000 not counting their home, cars and home furnishings.
  • A Form D must be filed with the SEC, the California Department of Business Oversight and with the securities regulators of the states where the investors are located. It is a notice filing; the SEC does not review your offering. Failure to file the form does not blow the exemption unless you are engaged in advertising. If you advertise a 506 offering (referred to as a “506(c)” offering) you are required to file a Form D with the SEC so indicating at least two weeks before you start advertising.
  • Advertising is allowed if you file the proper Form D and you verify that your investors are “accredited.” You can’t simply take their word for it.

I advise clients to use the Lender/Purchaser Disclosure Statement and a special subscription agreement when relying on Rule 506.

© Doss Law, LLP. Attorney advertising materials. These materials have been prepared for educational purposes only and are not legal advice.  This information is not intended to create an attorney-client relationship.  Consult a knowledgeable lawyer before implementing any of the ideas in this publication.

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