If a person is a California real estate broker and makes or arranges real property loan transactions using private party investors to fund the loans, the broker is subject to a fiduciary duty to disclose all material facts and investment risks either known or should have known. This includes facts discovered during processing or underwriting the loan. The investor’s decision to invest in a proposed loan transaction will include the investor’s review of the material disclosure package including the investment risks and a written affirmation about the investor’s background, knowledge, and experience to ensure that the contemplated transaction is “suitable.”
A fiduciary is a relationship in which one party places special trust, confidence, and reliance and is influenced by another who has the duty to act for the benefit of the first party. Real estate/mortgage brokers have a fiduciary duty to private party investors as their agent.
Actual investors may be single individuals, husbands, and wives as community property, family trusts, or family partnerships that elect (subject to documented authority) to invest in real property loan transactions for the purpose of generating an expected monthly cash flow greater than some alternative investments they may have considered.
The private party investors in fractionalized or multi-lender loan transactions are also typically subject to mutual agency relationships owing fiduciary duties to each of the other investors within the structure of such transactions as required under applicable law.
If the total loan is $500,000, there may be multiple fractional lenders of that loan transaction referred to as fractional beneficiaries who will hold the title as an undivided tenants-in-common. Mr. and Mrs. Archie and Edith Bunker invested $100,000 or 20% of the loan transaction. Mr. and Mrs. Michael and Gloria Stivic, a family trust invested $200,000 or 40% of the loan transaction. Other individuals or lawfully authorized entities who will also own part of the loan transaction as tenants-in-common invested the remaining 40%. Other investors included Fred Sanford and George and Louise Jefferson.
Each, fractional beneficiary, owns a portion of the loan, evidenced by their names being placed upon the promissory note, deed of trust and recorded in public records. Multi-lender notes are pieces of evidence of indebtedness and are securities qualified by a statutory exemption. A statutory exemption refers to the exemption from getting a permit or registering the offering under federal and/or state securities laws.
Let’s visit a legal contract concept referred to as the “covenant of fair dealing”. In contract law, there is a general presumption that the parties to a contract will deal with each other honestly, fairly, and in good faith, and not destroy the right of another party or parties relating to receiving their proportional benefits of the contract.
California multi-lender fractional beneficiary transactions are governed by a majority rule statute or 2941.9 of the Civil Code. There may be decisions necessary by the investor parties to be made relating to the disposition of the loan and/or the property, such as “Should we file a notice of default?”; “Should the investors agree to a reasonable workout payment plan for a defaulted borrower and extend the loan period with the borrower to avoid triggering a formal default?”; “Should we as investors instruct the servicing agent to have the property boarded up, or spend $30,000 for a cosmetic fix-up to enhance a potential up-side profit on resale; or do we sell immediately at a distressed price and achieve a quick sale?”.
The fractional owners of the loan have a vote, based upon a majority or 50.1% of the secured interest. The real estate broker/mortgage broker may have the sophistication to propose the best course of action for everyone concerned but cannot make the decision. Investors will often vote to what they perceive is in their best interest. (The brokers, or an affiliate thereof, cannot vote. They can only recommend action.)
Does anyone remember the “Along Came Jones” recorded in 1959 by the Coasters?
I plopped down in my easy chair and turned on Channel 2
A bad gunslinger called Salty Sam was chasin’ poor Sweet Sue
He trapped her in the old sawmill and said with an evil laugh,
‘If you don’t give me the deed to your ranch
I’ll saw you all in half!’
I have worked with many “Salty Sams’,” who possessed a selfish and contrary agenda from the best interest of the other investors. For example, Sam may perceive that if he holds out and disagrees with any action at all, that all the other investors will get frustrated, and sell their interest to Sam at a discount just to avoid the aggravation. Sam is convinced that he can act as a predator for self-gain and get the keys to the ranch.
It is difficult for a mortgage broker who deals with private party investors to identify and reject those Salty Sam type investors who are predators searching for the next opportunity. Yes, they exist. Salty Sam is unaware of the mutual agency responsibilities of tenants-in-common relationship engaged in a joint venture enterprise for gain or profit holding interests (including mortgage loans) in real property.
Sam forgot that there is a majority rule mechanism, and the overlying body of law referred to “the covenant of fair dealing”.
If the servicing mortgage broker followed all the requirements of 2941.9 of the civil code, and Sam refused to comply with the voted action by the majority then the servicing broker on behalf of all the investors may file a superior court action called a “motion to compel” to get Sam to comply. One instance I recall is when a Sam styled predator investor lost and was ordered by the court to comply with majority rule and ordered by the judge to pay $35,000 in attorney’s fees, and court-related expenses. The court ordered compliance with 2941.9 of the civil code and issued an order that the hold-out investor had to pay $35,000 out of his capital investment. Hallelujah, jerks referred to here as Sam, do not always win.
Business and Private Money Finance Consultant
Cell (949) 533-8315
I intend this article for educational purposes only and is not a solicitation.