California's security exemption for deeds of trust on real property

California Security Exemption for Notes Secured by Realty

You are looking for a security exemption, and you think that you can finance your real estate deal with a Deed of Trust. California Corporations Code sets rules for securities in California that are separate from the federal (SEC) regulations. You might have already evaluated whether your security is exempt for SEC registration, but is your security also exempt under California law?

One exemption that is particularly interesting to real estate investors, wholesalers, and real estate rehabbers and flippers is found in subdivision (p) of section 25100:

“A promissory note secured by a lien on real property, which is neither one of a series of notes of equal priority secured by interests in the same real property nor a note in which beneficial interests are sold to more than one person or entity.” ¹

When an investor buys from distressed sellers, or when he or she sells to buyers who cannot qualify with a bank, the Deed of Trust security exemption allows the investor some flexibility. The investor may use seller-financing, when it conforms to the law, because “[a] promissory note secured by a lien on real property is expressly exempted from the requirements of section 25110. Cal. Corp. Code § 25100(p).”²

Elements of the security exemption

We can break the security exemption down into four elements: (1) the security must be a promissory note (this excludes stocks and other securities), (2) the security must be recorded as a lien on real property (i.e. a deed of trust), (3) and the note must be recorded in such a manner that it does not share priority with any other lien on the property, and (4) the note must have a single beneficiary. ³

Multiple Promissory Notes not excluded

According to the court in People v. Schock (1984) 152 Cal.App.3d 379, 390, any attempt to issue more than one Deed of Trust on a property exceeds the scope of the exemption:

The exemption from corporate security regulations has been consistently limited to a single promissory note secured by real property traditionally within the jurisdictional supervision of the Real Estate Commissioner. (See § 25100, subd. (e) and Bus. & Prof. Code, § 10131, subd. (e).) A reasoned construction providing harmony among the related regulations evidences a legislative design that a secured transaction involving a series of promissory notes was intended to be governed under the Corporate Securities Law.⁴

Single Promissory Note with multiple parties not excluded

In People v. Schock, supra, 152 Cal.App.3d 379, the defendant attempted to bypass the single promissory note rule with a clever twist.⁵ Schock’s company issued a single promissory note that had multiple beneficiaries; each beneficiary had a percentage interest in the singular note.⁶ He argued, that because all the investors were named on the same promissory note that it met the exemption requirements, but the court thought differently:

[A]lthough each transaction took the form of a single promissory note, fractional interests in each note and trust deed were assigned to each investor reflecting their undivided beneficial interests therein. Unmistakably, the fractionalizing process employed was no different in substance than the issuance of a series of notes secured by the same real property.⁷

Security Exemption Summary

Under subdivision (p) of California Corporation Code section 25100, a real estate investor may create a single Deed of Trust on a single parcel of real estate tied to a single promissory note with a single drawer. This rule allows people who have sufficient funds or financial stability to transfer property or invest in property dealings without exposing the segments of the public to risk.

This rule does not cover all that you need to know; more articles will follow on this topic. For example, this rule does not provide the issuer a right to advertise. It does not qualify the note based on the creditor’s accredited investor status. Neither does it specify minimum or maximum amounts. It does limit the investors ability to bring in multiple investors on a single project using Deeds of Trust absent qualification and possibly registration.

What next?

Want more information? Try reading one of our other investor articles available now:

California Security Exemptions: Deeds of Trust