Another Usury Exemption For California Lenders

Nov 28 2016

Law360, New York (June 17, 2013, 12:37 PM EDT) -- When Californians first
passed an initiative precluding the charging of “usurious” interest in 1918, they
could hardly have imagined the ever-more sophisticated schemes, and endless
exceptions, which allow lenders to charge interest exponentially higher than the
stated maximum rate of 10 percent. Indeed, the days of the neighborhood loan
shark have given way to unashamed lenders who freely advertise on the television
or radio, obtaining interest on their loans that exceed 20, 30 or even 100 percent.
Recently, the California Court of Appeal for the Third Appellate District introduced
yet another exception to a seemingly simple prohibition on charging usurious interest. In Bock v.
California Capital Loan Inc., the court held that a broker who owns the lending corporation and
solely expects to receive “compensation” through the interest received on the loan, as opposed to
a fee or commission in “arranging” the loan, falls within the exceptions to the usury law. For all
practical purposes, the case provides a broad exception to so-called “hard money lenders” in real
estate loans.

California Constitution Article XV § 1 limits the interest rate charged on loans for real property at
10 percent. There are, however, numerous exceptions to this rule. Of particular importance,
pursuant to California Civil Code section 1916.1, “[t]he restrictions upon rates of interest
contained in Section 1 of Article XV of the California Constitutional shall not apply to any loan or
forbearance made or arranged by any person licensed as a real estate broker by the State of
California, and secured, directly or collaterally, in whole or in part by liens on real property.”[1]
Licensed real estate brokers “may be either individuals or corporations. When a license is issued
to a corporation, it is through the license of a designated individual of the corporation. If there is
no licensed officer, no licensed activities may be performed for or in the name of the corporation.
When there is a designated officer, only the designated officer may conduct activities on the
corporation’s behalf. Other officers may act under the corporation’s license only if the corporation
procures additional licenses to employ each additional officer.”[2] The exemption does not apply to
loans arranged by real estate salespersons on their own.[3]
A loan is “made” for purposes of Civil Code section 1916.1 when a broker loans personal funds as
a principal and not as an agent.[4]

A loan is “arranged” by a broker in three circumstances[5]: (1) the broker “acts for compensation
or in expectation of compensation for soliciting, negotiating, or arranging the loan for another; (2)
The broker “acts for compensation or in expectation of compensation for selling, buying, leasing,
exchanging, or negotiating the sale, purchase, lease, or exchange of real property a business of
another and (A) arranges a loan to pay all or any portion of the purchase price … or (B) arranges
a forbearance, extension, or refinancing of any loan in connection with that sale ...” or, (3) The
broker “arranges or negotiates for another a forbearance, extension or refinancing of any loan
secured by real property in connection with a past transaction in which the broker had acted for
compensation or in expectation of compensation …”

In order to fall under the exception to Civil Code section 1916.1, the broker must “act[] for
compensation or in the expectation of compensation for soliciting, negotiating, or arranging the
loan for another.”[6] Thus, “a loan is arranged by a person licensed as a real estate broker only if
two things occur. One is that the broker acts for another or others, not for himself. The other is
that he receives or expects to receive compensation.”[7]

Accordingly, the arranging “must refer to some conduct by a real estate broker, acting as a
third-party intermediary rather than as a party to the loan, that causes the loan to be obtained or
procured.”[8] Moreover, “where the transaction is between borrower and lender, each acting on his
own behalf, and there is no third-party licensed real estate broker acting for compensation as
intermediary, the loan is not ‘arranged’ by a broker …”[9]

In the Bock case, the court focused on the meaning of “arranging the loan for another” as well as
the “expectation of compensation.” Bock, who was in need of a loan, was connected with
Speckert, a licensed real estate broker. Speckert was also the sole shareholder of California
Capital Loans. After exchanging documents, including a real estate disclosure statement,
California Capital loaned Bock $1.2 million secured by a deed of trust on Bock’s property. The
terms of the loan called for 15 percent interest, with interest-only monthly payments until
maturity, at which point the entire principal balance was due. Ultimately, Bock defaulted on his
payments and California Capital foreclosed on the property. Bock sued, alleging that because the
interest exceeded California’s maximum limit, the trustee’s sale was void. The trial court found
that the loan was exempt and the Court of Appeal agreed.

Bock contended that the exemption under Section 1916.1 was inapplicable because (1) Speckert,
while a licensed real estate broker, did not directly receive compensation in arranging the loan,
and (2) he could not have “arranged” the loan for another because the lender was his wholly
owned corporation. The court rejected these arguments.

The court held that Speckert “arranged” the loan in multiple respects to justify the applicability of
Section 1916.1. On the one hand, it could be said that Speckert arranged the loan for Bock. To
that end, the court conducted a factual inquiry and found that Speckert performed the functions of
a real estate broker pursuant to California Business and Professions Code section 1013, which
provides that real estate brokers can provide services for both borrowers and lenders, provided
that they make the required real estate disclosures.

On the other hand, the court recognized that Speckert has a separate identity from that of his
corporation. “It is fundamental that a corporation is a legal entity that is distinct from its
shareholders.”[10] The court stated that, “California Capital qualifies as ‘another’ for purposes of
the loan Speckert arranged, even though Speckert was the sole shareholder of the corporation.”
Thus, Speckert could also be seen as arranging the loan for California Capital. Importantly, the
court did note that no attempt was made to “use the alter ego doctrine to pierce the corporate
veil” of California Capital, a strategy which have much different results.

With respect to the question of compensation, the court essentially pierced the corporate veil on
its own and held that Speckert did act for compensation because, as the sole shareholder of
California Capital, he would reap the profits when Bock made his interest payments. Following a
line of earlier cases, the court explained, “within the context of other statutes, compensation is a
concept which has received and extremely broad definition sufficient to encompass the receipt of
just about any form of monetary or tangible benefit that is not self-bestowed …”[11]
The court found the instant case to be analogous to earlier cases where “anticipated profits qualify
as compensation.” Applying those principles, as the sole shareholder of California Capital,
Speckert could have expected to reap the benefits of the interest his corporation was supposed to
earn on the loan, or about $540,000. Thus, it was not important when Speckert was to receive the
payment, nor whether his payment was coming from Bock or California Capital, but merely that
he expected to receive compensation.

Critically, what sets the Bock case apart from others is that the court distinguished Speckert’s role
in arranging the loan from his role in receiving compensation as a shareholder of California
Capital. The court explained, “in this case, the trial court implicitly found that Speckert arranged
the loan at issue by acting in his individual capacity as a licensed real estate broker …”
The Bock case provides guidance to both lenders and borrowers. For lenders, the case provides
additional protections for the receipt of higher interest. The framework in which the case played
out is not one that is difficult to replicate. A real estate broker must merely establish a separate
lending entity to fund the loan and then “arrange” the loan in an individual capacity in order to
take advantage of the protections afforded by Section 1916.1.

For borrowers attempting to escape usurious interest, their counsel should look carefully at the
roles played by real estate brokers in “arranging” the transaction. Speckert’s situation is
somewhat unique in that he acted in his individual capacity as the real estate broker arranging the
loan. If, for example, a different employee of California Capital who was not so licensed, arranged
the loan, the determination could have been far different. Similarly, if California Capital had other
members or shareholders, Speckert’s expectation of compensation would not be so
straightforward. The court also suggested that borrowers in this situation should explore whether
to plead alter ego, thereby removing the distinction between the corporation and its sole
shareholder.

—By Brian D. Lauter and H. Mark Madnick, Robins Kaplan Miller & Ciresi LLP
Brian Lauter is an associate in the Los Angeles office of Robins Kaplan. He practices in real estate
litigation, complex business litigation and franchise litigation.

Mark Madnick is an associate in the firm's Los Angeles office and practices in the areas of real
estate litigation and business litigation.

The opinions expressed are those of the authors and do not necessarily reflect the views of the
firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for
general information purposes and is not intended to be and should not be taken as legal advice.
[1] Cal. Civ. Code § 1916.1.
[2] Creative Ventures, LLC v. Jim Ward & Associates, 195 Cal. App. 4th 1430, 1442 (2011).
[3] People v. Asuncion, 152 Cal.App.3d 422, 424-426 (1984).
[4] Cal Civ. Code § 1916.1; Winnett v. Roberts, 179 Cal. App. 3d 909, 917 (1986); Miller & Starr,
California Real Estate, § 21.34.
[5] Cal Civ. Code § 1916.1.
[6] Cal. Civ. Code § 1916.1 (emphasis added).
[7] Green v. Future Two, 179 Cal. App. 3d 738, 742-743 (1986).
[8] Gibbo v. Berger, 123 Cal. App. 4th 396, 402 (2004).
[9] Winnett v. Roberts, 179 Cal. App. 3d 909, 921 (1986).
[10] Frosset v. Wenaas (2008) 42 Ca.4th 1100, 1108.
[11] citing Stickel v. Harris (1987) 196 Cal.App.3d 575, 584.

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