California Hard Money Lenders – When Investors Are Not Holders In Due Course, And Are Liable For Usury

A recent decision out of Santa Clara County found that some investors in hard money loans were not holders in due course, and had to pay back all their interest, all because the broker was mistaken as to whether his corporation was licensed. Experienced California real estate lawyers always check the DRE license status; but this broker’s attorney did not.

A hard money lender makes loans that do not conform to bank standards (and thus pay higher interest) and are secured by real estate. If the broker has a real estate license, they are not subject to California usury laws.

In Creative Ventures v. Jim Ward , a licensed broker retired and closed his hard money corporation. He came out of retirement, formed a new business to lend money (“JWA”), applied for a brokers license, but apparently the license was never placed with the corporation. JWA held itself out to be licensed, and the Promissory Notes indicated that it was. JWA arranged to lend close to 3 million to a developer with several promissory notes. Meanwhile, the DRE did an audit, and notified JWA’s attorney, before the deals were final, that they did not believe JWA was licensed (Yikes!). The deals closed, and JWA solicited 54 individual investors.

Between the fees and interest, the total result of the notes yielded over ten percent, the maximum allowed by California usury law. The individual investors were assigned fractional interests in the notes. The broker found out that JWA was not licensed, and sued for usury. In California, a successful claim of usury requires all interest to be refunded to the borrower, plus provides a possibility for treble (three times) in damages.

The individual investors claimed that the notes were negotiable instruments, and as such the investors were holders in due course, protected by the Commercial code, and should not be liable. The court said no. under the Commercial Code, a “holder in due course” is the person in possession of a negotiable instrument payable to bearer or an identified person who is the one in possession. Commercial Code section 1201.

These notes were payable to JWA, who was in possession, and “all assignees.” However, an assignee can be anybody, impossible to identify. The notes could have been ‘endorsed’ or ‘indorsed’, signed by JWA and physically transferred to investors, which could have protected them. This would transfer the instrument itself, while an assignment only transfers legal rights in or concerning the instrument. The assignees stand in the shoes of the assignor, and obtains only the rights JWA has, subject to the developer’s defenses.

This is a problem that may appear with increasing frequency as the California real estate industry continues to unravel, and the concerned investors should be consulting with experienced California business attorneys. Hard money loans are made by investors because of the high interest rates the can get. The lending brokers often retain control of the notes to service them; they may never be indorsed, let alone be handed over to the investor. As recently reported by Robert Lewis in the Sacramento Bee, these lenders have a sordid history.

Licensing and usury aside, any defenses the borrower has against the lender, including fraud, may be raised against the investors if the are not holders in due course.