PRIVATE INVESTORS/LENDERS

PRIVATE INVESTORS/LENDERS

Private Money Loan Transactions

Loans funded by private investors/lenders and arranged by MLBs that are secured directly or collaterally by
liens on real property (deeds of trust or mortgages) have been historically referred to as “hard money” loans.
Whether the proceeds of the loan funded by private investors/lenders are for the purchase of the intended
security property or used to further encumber or refinance existing encumbrances (including the payment of
additional net proceeds to the borrower known as an “equity loan”), the term “hard money” has been
historically applied to such transactions.

The term “hard money” has also been applied to loan transactions funded by depository institutions and
licensed lenders when the loan proceeds are used to refinance existing encumbrances or to further encumber the
security property (including loan transactions where additional net proceeds are paid to the borrower known in
this setting as a “cash-out refinance”). The discussion in this Section is intended to apply to loan transactions
made or arranged by MLBs with the capital/funds of private investors/lenders.

MLBs also make and arrange loans relying on capital/funds from private investors/lenders where the loan
proceeds are used to purchase, develop, or improve the intended security property (land acquisition and
development or vertical construction loans). In addition, loans made or arranged by MLBs may be secured by
either senior or junior deeds of trust or mortgages.

Many practitioners have redefined making and arranging loans with the capital/funds of private
investors/lenders as “private money” transactions. Investment bankers and broker-dealers refer to the use of
funds from private investors/lenders as “private equity capital”. The traditional term “hard money” has given
way to industry use of the terms “private money” or “private equity capital”. As a cautionary note, the use of
“private money” in a loan transaction does not excuse MLBs from following applicable federal and state law,

including (among others) standards imposed regarding the appraisal of the intended security property and the
underwriting of the borrower’s credit worthiness and financial standing.

As agents and fiduciaries, MLBs remain subject to the responsibility of ensuring that a reasonable method of
repayment of the debt/loan has been established and that the borrower is capable of paying the required
mortgage debt service throughout the term of the loan, i.e., the proposed loan transaction is suitable for the
borrower. Equally, MLBs must assess whether the intended loan transaction is suitable for the private
investors/lenders whose capital/funds are being relied upon to make or arrange the loan. (Business and
Professions Code Sections 10131(d) and (e), 10131.1, 10131.3, 10176, 10177, 10232.4, .5 and .6, 10238(h)(3)
and (4), 10240 et seq., including 10241.3 and 11302(b), among others).

Transactions with Private Investors/Lenders are Securities

When relying on capital/funds obtained from private investors/lenders for loans secured directly or collaterally
by liens on real property (deeds of trusts or mortgages), MLBs must be aware they are performing in three roles
under the Real Estate Law and the Corporate Securities Law of 1968 and the respective Commissioners’
Regulations pertaining to each. The three roles include issuer, real estate broker acting within the course and
scope of his or her license as an agent and fiduciary, and de-facto broker/dealer (Business and Professions Code
Sections 10131.3, 10177.6, 10177(q), 10230 et seq., and 10240 et seq., and 10CCR, Chapter 6, Section 2840 et
seq. among others; Civil Code Sections 2295 et seq. and 2923.1; Corporations Code Sections 25019, 25100(e),
25206, and 10CCR, Chapter 3, Sections 260.115 and 260.204.1, among others).

If the loan is evidenced by promissory notes issued in series secured by the same deed of trust or mortgage,
secured by more than one deed of trust or mortgage of equal priority, or “fractionalized” interests in the
promissory notes are sold to private investors/lenders (in “multi-lender” transactions), the loan or the purchase
of the promissory notes or interests therein must occur through MLBs (Business and Professions Code Sections
10131.3, 10177(n) and 10237 et seq.; and Corporations Code Sections 25100(e), 25102(e), 25102(f), 25102(n),
25102.5 and 25206, and 10CCR, Chapter 3, Sections 260.115 and 260.204.1, among others).

These private investors/lenders are usually persons desiring higher returns on the capital/funds invested in
exchange for higher risks than might occur in other forms of investment vehicles. It is possible investments in
promissory notes and deeds of trusts may result in lower risks than some alternative investment vehicles.
Individual private investors/lenders acting for their own account in “whole note” loan transactions without the
loan being arranged by MLBs must still operate within applicable federal and state law governing lending and
usury.

Disclosures Required

Private investors/lenders making loans through MLBs must receive disclosures pursuant to Sections 10176,
10177, 10232.4, 10232.5, 10232.6, and 10237 et seq. of the Business and Professions Code, and 10CCR,
Chapter 6, Section 2846, among others, including any additional disclosures regarding material facts and
investment risks required under the Corporate Securities Law of 1968 and the Corporations Commissioner’s
Regulations pertaining thereto (Corporations Code Section 25000 et seq. and 10CCR, Chapter 6, Section
260.100 et seq.). These disclosures must be made to private investors/lenders prior to the MLB committing the
private investor/lender’s capital/funds to loan transactions or to the purchase of interests in promissory notes
and deeds of trusts or mortgages.

Borrowers must receive disclosures from MLBs pursuant to Sections 10176, 10177 and 10240 et seq. of the
Business and Professions Code and 10CCR, Chapter 6, Section 2840 et seq., among others, prior to becoming
obligated to complete the loan transaction.

Whether required to be delivered to private investors/lenders or to borrowers, the objective of these disclosures
is to ensure that in either residential or commercial loan transactions (as defined), the principals are making
informed and considered decisions to extend credit or to borrow the money, and the proposed loan transactions
are suitable for the intended private investors/lenders and the borrowers.

Usury

Private investors/lenders may loan money directly or they may benefit from the usury exemption by lending the
funds through an MLB. In California, the passage of Proposition 2 in 1979 made significant changes to the
constitutional provisions defining and controlling usury. Thereafter, loans secured directly or collaterally by

liens on real property in the form of deeds of trusts or mortgages made or arranged by licensed real estate
brokers (acting as MLBs) became exempt from the usury law.

The California Legislature has applied the usury exemption to loans or forbearances made or arranged by
licensed real estate brokers (whether acting as MLBs or as brokers in connection with a related real property
transaction) that are directly or collaterally (in whole or in part) secured by liens (deeds of trusts or mortgages)
on real property (Civil Code Section 1916.1). The usury exemption extended to real estate brokers (MLBs)
applies regardless of the nature of the intended security real property.

Whether a loan made or arranged by a real estate broker (MLB) may be secured “… in whole or in part by liens
on real property …” is controversial in the real estate and mortgage industries and among some members of the
legal community (Civil Code Section 1916.1). Some observers believe this phrase authorizes MLBs to make or
arrange loans secured in part by business or other forms of personal property (including the pledging as
additional collateral of other non-real property security interests) even though the real estate license authority
for such brokers does not extend beyond loans secured directly or collaterally by liens on real property.

Other observers believe the language was intended to preserve the usury exemption when real estate brokers
(MLBs) made or arranged part of the loan within the course and scope of their license authority with the
remaining part of the loan being made or arranged by other lenders acting within their license authority. A
further interpretation has been applied in narrow circumstances, i.e., when the loan is made in part directly by a
principal (person or entity) without the benefit of a license.

A principal acting directly raises additional questions involving the Securities Law and the applicable license
law, e.g., a real estate broker’s license is required when performing as a mortgage broker (MLB) to issue
“multi-lender” promissory notes (Business and Professions Code Sections 10131.3 and 10237; Corporations
Code Section 25102.5 and 10CCR, Chapter 3, Sections 260.115 and 260.204.1). Regardless of interpretation,
MLBs are unable to include other than the real property security when establishing loan-to-value ratios required
pursuant to Business and Professions Code Section 10238(h)(1) and (2).

A real estate broker arranged extension, forbearance, or refinancing of a loan secured in whole or in part by a
lien on real property (deed of trust or mortgage) in which the broker had originally been compensated (even
though not being specifically compensated for arranging the new credit terms) is also exempt from the usury
law. As previously mentioned, private investors/lenders making loans or engaging in such transactions
involving new credit terms without having the transaction arranged by a real estate broker are controlled by and
subject to the usury law (Article 15, Section 1 of the California Constitution; Civil Code Section 1916.1; Gibbo
v. Berger (2004) 123 Cal.App. 4th 396, and In re Lara, 731 F.2d 1455, 1459 (9th Cir. 1984)).

“Multi-Lender” Promissory Notes

Notes in series which are secured by a single deed of trust or more than one deed of trust of equal priority, or
notes providing fractionalized interests to no more than 10 investors/lenders (as defined) are securities requiring
issuance pursuant to the “quasi-private placement” exemption (as defined) set forth in Business and Professions
Code Section 10237 et seq., and in Corporations Code Section 25102.5. The phrase “quasi-private placement”
as used in this discussion means a “private placement”, which unlike any other such offering allows the issuer
to market to private investors/lenders through media and to accept funds from the foregoing even though no
preexisting business relationship exists with the issuer.

When private investors/lenders fund or make loans evidenced by promissory notes or purchase interests in
promissory notes, the issuance of securities must be addressed to ensure compliance with the Corporate
Securities Law of 1968 and the Corporations Commissioner’s Regulations pertaining thereto, particularly
Corporations Code Sections 25019, 25102 et seq., and 25110 et seq. The “quasi-private placement” exemption
is structured to allow “multi-lender” promissory notes to be issued without requiring the issuers to otherwise
qualify the offering by “exemption” (a private placement) or by “registration”.

The offering of securities must either be qualified pursuant to Sections 25110, 25120, or 25130 of the
Corporations Code, i.e., “registered” with and permitted by the DOC, or the securities must meet an exempt
“issuer” or “nonissuer” status, arise from an exempt “issuer” or “nonissuer” transaction, or from a transaction
exempt through issuance to a “qualified purchaser” (Corporations Code Section 25100 et seq.). The foregoing

“exemptions” must meet each of the standards and requirements imposed pursuant to the Corporate Securities
Law of 1968 and the Commissioner’s Regulations pertaining thereto.

If the issuer fails to meet each of the standards and requirements imposed to issue an offering pursuant to an
applicable “exemption”, the offering would be issued in violation of the Securities Law. Accordingly, the issuer
may be subject to an enforcement action for securities fraud due to the failure (among other violations) to
appropriately qualify the offering with the DOC, i.e., “registering” with and obtaining a permit from the DOC.
There are no exemptions from the Corporate Securities Law of 1968 and the Corporations Commissioner’s
regulations pertaining thereto for fraud or misrepresentation. Furthermore, the failure to comply with the
standards and requirements imposed for the applicable “exemption” negates the “exemption”, and the burden of
proving “…an exemption or an exception from a definition is upon the person claiming it” (Corporations Code
Section 25163).

For the purposes of this discussion, offerings of securities that meet the exempt “issuer” or “nonissuer” status,
arise from an exempt “issuer” or “nonissuer” transaction, or from a transaction exempt through issuance to a
“qualified purchaser” will be referred to as securities qualified by “exemption”. Offerings qualified with the
DOC and for which a permit has been issued will be referred to as securities qualified by “registration”.
Accordingly, the offering of securities must be qualified either by “exemption” or by “registration” with the
DOC (if the securities are to be issued intrastate) and qualified by coordination with the Securities and
Exchange Commission (SEC) when the securities are to be issued both intra and interstate.

Coordination with the SEC is also required if the issuer is unable to qualify the securities under the exemption
extended through Regulation D of the Securities Exchange Act of 1933, Section 18(b)(4), and as authorized in
17CFR Section 239.500. Among the standards imposed to qualify by exemption through Regulation D is the
requirement that 100 percent of the private investors/lenders and 80 percent of the business of the issuer must
be within the same state (Rule 147 promulgated by the SEC).

The issuance of securities by MLBs to private investors/lenders is a very complex matter requiring a practical
understanding (at a minimum) of an extensive body of law, including the Corporate Securities law of 1968 and
the Corporations Commissioner’s Regulations pertaining thereto (Corporations Code Section 25000 et seq. and
10 CCR, Chapter 3, commencing with Section 260.100). A further discussion is included later in this Chapter
regarding “multi-lender” transactions authorized by Article 6 of the Business and Professions Code (as noted, a
“quasi-private placement”).

Subdivision Projects

In recent years, MLBs have arranged loans funded by private investors/lenders secured by raw land for which
entitlements were to be obtained, entitled land for purposes of development of offsite (including backbone) and
onsite improvements, or for financing vertical construction of building improvements. These loans were made
or arranged in connection with subdivision projects. The term “backbone” when describing offsite
improvements refers to improvements required by a local political subdivision as part of the necessary public
infrastructure to accommodate the development/subdivision.

These loan products are subject to high although diminishing risks depending upon the stage of the project. The
highest risk is when the security property is raw land and the loans are made in advance of receiving
entitlements. The second level of risk is associated with loans to finance post entitlement land development of
offsite (including backbone) and onsite improvements. The third level of risk is the financing of the vertical
construction representing the improvements to be built upon the land. Each of the foregoing represent loans for
speculative objectives and, therefore, is an example of loans funded with “risk capital”.

In each case, the financing obtained from private investors/lenders represents “risk capital” which must be
distinguished from other forms of loan transactions in the securities offerings made to the public or pursuant to
an authorized exemption (private placement). The “quasi-private placement” authorized pursuant to Article 6 of
the Business and Professions Code, commencing with Section 10237 and pursuant to Corporations Code
Section 25102.5, is a securities specific exemption from otherwise qualifying by exemption or registration with
the DOC (and by coordination with the SEC, if applicable). This exemption is known as the “multi-lender
statutory exemption”.

MLBs as issuers, real estate broker agents and fiduciaries, and as de-facto broker-dealers must carefully follow
without deviation the provisions of the statutory “multi-lender” exemption and the related requirements of the
Real Estate Law. It is strongly recommended that MLBs not engage in the financing of land intended for
subdivision development, in the financing of offsite (including backbone) and onsite improvements, or in the
financing of vertical construction (including rehabilitation loans) without first obtaining the advice of
knowledgeable construction and securities legal counsel.

Whether a vertical construction loan is intended to finance a single spot loan for an identified borrower or is
intended to finance the construction of homes on a speculative basis within a subdivision project, permanent or
“take out” financing should be considered by the borrower and the private investors/lenders. MLBs acting as
agents of the private investors/lenders must undertake to underwrite adequately the borrower and the
subdivision project to determine whether a reasonable expectation exists to obtain permanent financing to pay
off the development or construction loan upon completion of the improvements.

It should be clear that engaging in the issuance of securities (whether in the form of a “multi-lender” transaction
authorized by Article 6 of the Business and Professions Code, through an offering otherwise meeting the
standards and requirements for exemption, or an offering qualified by registration) is a matter involving a
significant amount of complexity. Practitioners should not engage in the issuance of securities (whether the
investment vehicle is an equitable or fee interest in the title to or a mortgage interest in real property) without
the prior advice of knowledgeable securities legal counsel.

Article 5 – Private Investors/Lenders

The Real Estate Law imposes certain duties and restrictions on real estate brokers (MLBs) who make or arrange
mortgage loans directly or collaterally secured by liens on real property (deeds of trust or mortgages). MLBs
may act in the secured transaction as either a principal making the loan with the broker’s own funds or with
funds the broker controls (as defined), or as an agent of the private investors/lenders or of the borrower, or
both.

MLBs may also act as agents of the principals for the purpose of buying, selling, or exchanging existing
promissory notes secured directly or collaterally by liens on real property (deeds of trust or mortgages). When
MLBs are selling and assigning interests to private investors/lenders in mortgage loans they have funded with
their own capital or through independent credit lines they have obtained for this purpose, MLBs are required
(pursuant to the Corporate Securities Law of 1968 and the Corporations Commissioner’s Regulations
pertaining thereto) to act as the agent and fiduciary of the private investors/lenders.

Real property sales contracts are marketing agreements and security devices/instruments rolled up into one
document. While such contracts are authorized under California law, federal law has preempted applicable state
law thus prohibiting the use of real property sales contracts when the property described therein is encumbered
by deed(s) of trust or mortgage(s) that include due-on-sale or due on further encumbrance clauses (the Federal
Depository Intuitions Act of 1982 also know as the Garn-St. Germain Act.) Further, real property sales
contracts are subject to significant issues regarding the remedies available to the seller/vendor in the event of a
breach or default by the buyer/vendee. For the foregoing reasons, this Chapter focuses on promissory notes and
deeds of trust or mortgages rather than on real property sales contracts. Practitioners should not engage in the
use of real property sales contracts without the prior advice of knowledgeable legal counsel.

Application of Article 5

The passage of Proposition 2 in November 1979 eliminated interest rate limits on real property secured loans
“made or arranged” by real estate brokers (MLBs). The Legislature responded in 1981 and 1982 by extensive
additions to the Real Estate Law, specifically to Articles 5 (governing transactions in deeds of trust primarily
with private investors/lenders) and to Article 7 (governing real property loans in connection with the duties and
obligations owed to borrowers).

Article 5 (Sections 10230 - 10236.6 of the Business and Professions Code) is applicable to arranging the
funding of mortgage loans by private investors/lenders who are non-institutional (other than depository
institutions) and are not themselves licensed as lenders. Article 5 is also applicable to the buying, selling or
exchanging of promissory notes and deeds of trust or mortgages (including interests therein) on behalf of
private investors/lenders.

The provisions of Article 5 also apply to real estate brokers (MLBs) who engage in secured transactions as
principals in buying from, selling to, or exchanging promissory notes and deeds of trust or mortgages with the
public and to MLBs who make agreements with the public for the collection of payments or the performance of
services in connection with promissory notes and deeds of trust or mortgages. The Securities Law integrates
with Article 5 and alters the principal-only role of the MLB when selling to or exchanging promissory notes
and deeds of trust or mortgages with private investors/lenders. As previously mentioned, MLBs engaging in
such transactions are required to be the agents and fiduciaries of the private investors/lenders (Business and
Professions Code Section 10131.3, Corporations Code Sections 25100(e) and 25206, and 10CCR, Chapter 3,
Sections 260.115 and 260.204.1, among others).

Pooling of Loan Funds

Pooling of funds from private investors/lenders’ is prohibited except as authorized through qualification by
exemption or registration of the offering issued through a permit obtained pursuant to the provisions of the
Corporate Securities Law of 1968 and the Corporation Commissioner’s Regulations pertaining thereto. As
previously mentioned, the Securities Law is administered by the DOC. Capital/funds of private
investors/lenders may be accepted for the funding/making of a specific loan or the purchase of a specific
promissory note or interests therein; unless the capital/funds were received through an offering qualified either
by exemption or by registration with the DOC that authorizes such pooling of funds (Business and Professions
Code, Section 10231 and Corporations Code Sections 25019, 25100, 25102, 25102.5 and 25110 et seq., among
others).

When the DOC processes an offering qualified by registration and the applicable requirements have been
satisfied, a permit is issued by the DOC (Corporations Code Section 25110 et seq.). Should the offering be
qualified by exemption, then the DOC is to be noticed pursuant to Corporations Code Section 25102.1 and in
accordance with the related regulations of the Corporations Commissioner. While it is important to comply with
the notice provisions of the Securities Law, the failure to notice the DOC may not in and of itself disqualify the
offering. However, practitioners should be aware that offerings qualified by exemption, pursuant to
Corporations Code Section 25102(f) may be limited to not more than one such offering during a 6-month
period before the start of an additional offering to be qualified under this exemption, i.e., not more than two per
year (10CCR, Chapter 3, Section 260.102.12).

“Multi-lender” or “fractionalized loans” and promissory notes are subject to the Securities Law (as defined).
Article 6 of the Real Estate Law, commencing with Section 10237 of the Business and Professions Code
(discussed later in this Chapter) is qualified by statutory exemption (as defined). MLBs who make or arrange
loans or who engage in the buying, selling, or exchanging of promissory notes with “fractionalized” interests
are issuing securities pursuant to Section 10237 et seq. of the Business and Professions Code and in accordance
with Corporations Code Section 25102.5.

Prior to making or arranging “multi-lender” loans or engaging in the buying, selling or exchanging promissory
notes or “fractionalized” interests therein, the MLB should obtain the advice of knowledgeable securities legal
counsel. Legal advice should also be obtained prior to engaging in any form of pooling of private
investor/lender funds.

A further word of caution should be added - while the buying, selling, or exchanging of promissory notes with
the public is authorized under the Real Estate Law, these activities are subject to the Securities Law and the
MLB’s participation therein may be limited or prohibited when relying on the “multi-lender” statutory
exemption, or in offerings qualified by exemption (Corporations Code Section 25104(a)).

“Threshold” Criteria

Except as otherwise provided in the Real Estate Law, a real estate broker (MLB) pursuant to Business and
Professions Code Section 10232(a) meets the “threshold” criteria if he/she intends or expects in any 12-month
period to perform or provide services regarding any of the following:

“(1.) Negotiate any combination of 10 or more of the following transactions pursuant to
subdivision (d) or (e) of Business and Professions Code, Section 10131 or Section 10131.1 in
an aggregate amount of more than $1,000,000:

(A.) Loans secured directly or collaterally by liens on real property or on business
opportunities as an agent for another or others;

(B.) Sales or exchanges of real property sales contracts or promissory notes secured
directly or collaterally by liens on real property or business opportunities as an agent
for another or others; or

(C.) Sales or exchanges of real property sales contracts or promissory notes secured
directly or collaterally by liens on real property as the owner of those notes or
contracts.

(2.) Make collections of payments in an aggregate amount of $250,000 or more on behalf of
owners of promissory notes secured directly or collaterally by liens on real property, owners
of real property sales contracts, or both.

(3.) Make collections of payments in an aggregate amount of $250,000 or more on behalf of
obligors of promissory notes secured directly or collaterally by liens on real property, lenders
(holders) of real property sales contracts, or both. Persons under common management,
direction, or control in conducting the activities enumerated above shall be considered as one
person for the purpose of applying the above criteria.”

If the lender or promissory note purchaser is a depository institution or a licensed lender (as defined), loans or
sales negotiated in connection therewith by a broker (MLB) or for which the broker (MLB) collects payments,
are not counted in determining whether the broker (MLB) meets the threshold criteria. Further, if the loan or
promissory note transaction occurs under the authority of a securities permit issued by the DOC, such
transactions are also not counted to determine threshold broker status. Pension trusts having a net worth of not
less than $15 million are also excluded from the count to determine threshold broker status. Generally, real
estate brokers (MLBs) dealing with private investors/lenders (whether as individuals or organized as members
or partners of a lawfully authorized entity) and small pension trusts are transactions to be counted to establish
threshold status (Business and Professions Code Section 10232 et seq.).

A threshold broker must notify the DRE in writing within 30 days of satisfying the criteria described in
Business and Professions Code Section 10232 (a) or (b). The notice is intended to advise the DRE the broker
(MLB) meets the threshold criteria and is performing as a threshold broker. Failure to timely inform the DRE in
writing is subject to a penalty of $50 per day up to and including the 30th day after the first day of the
assessment of the penalty and $100 per day thereafter up to a maximum fine of $10,000. The failure to timely
notice the DRE may result in the suspension or revocation of the license of the real estate broker (MLB).

A broker (MLB) who meets the threshold criteria must file with the DRE two annual reports within 90 days
after the end of the broker’s fiscal year and a quarterly trust fund status report within 30 days after each of the
broker’s first three fiscal quarters. The two annual reports are the Annual Report of a Review of Trust Fund
Financial Statements (TAR) and the Mortgage Loan/Trust Deed Annual Report (Business Activities). An
extension for filing the TAR is provided upon request, if the broker’s fiscal year ends between November 30
and the last day of February of the following year.

These required reports are filed under the penalty of perjury, and, if the broker (MLB) fails to timely file the
reports, the Commissioner may cause an examination and report of the MLB’s applicable books and records
and may charge the broker one and one-half times the cost of making the examination and completing the
report. If the broker (MLB) fails to pay the fee as billed, the Commissioner may suspend or deny the renewal of
the MLB’s license (Business and Professions Code Section 10232.2, 10232.25, and 10236.2).

Disclosure Statements

Business Professions Code Sections 10232.4 and 10232.5 require a real estate broker (MLB) to complete and
deliver to private investors/lenders (as defined), or pension trusts that are otherwise not exempt, a disclosure
statement known as the Lender/Purchaser Disclosure Statement setting forth, at a minimum:

1.

The terms of the loan or of the promissory note;

2. Pertinent information about the borrower (identity, occupation, income, credit data, as represented
to the broker by the prospective borrower, or as a result of a separate inquiry of the broker, or
through an inquiry of or a report(s) received from a third party, such as a credit reporting agency);

3. Pertinent information about the intended security property, including the address or other means
of identification, fair market value, age, size, type of construction and description of
improvements obtained from preliminary “title” and appraisal reports;

4. Provisions for loan servicing, including disposition/payment of late charges and prepayment
penalty fees;

5. Pertinent information concerning encumbrances which are currently liens against the security
property or of which the borrower has knowledge or notice and prospective/contemplated liens
which the borrower discloses or are known to the MLB to encumber the security property
presently or subsequent to the completion of the transaction;

6. Detailed information concerning any proposed arrangement under which the prospective lender
(private investor/lender or the trustee of a pension trust or plan, including when the plan is self
directed) will be joint beneficiaries or obligees, along with persons not associated with the private
investors/lenders or the trustees (e.g., engaged with other persons in “multi-lender” transactions);
and,

7. Whether the solicitation is subject to Business and Professions Code Section 10231.2, and if so, a
detailed description of the intended use of the funds being distributed including an explanation of
the nature and extent of the benefits to be directly or indirectly derived by the broker (MLB),
described as self-dealing (Business and Professions Code Section 10238 (e)).

The Lender/Purchaser Disclosure Statement must be delivered before the private investor/lender or purchaser of
a promissory note (or of interests in either the loan or promissory note), as well as a trustee of a pension trust or
a plan (including a self-directed plan) becomes obligated to complete the loan or promissory note purchase
transaction. When the MLB is engaged in self-dealing, this statement must be delivered to the DRE at least 24
hours in advance of receiving the funds from the private investor/lender (as defined above). Further, the issue
of self-dealing by an MLB is subject to the Securities Law and MLBs should not participate in such
transactions without the prior advice of knowledgeable securities legal counsel.

A real estate broker (MLB) who advertises for or solicits capital/funds from the public used for the broker’s
direct or indirect benefit must submit the format of the advertisement and of the disclosure statement to the
DRE for approval prior to such solicitation. Each Lender/Purchaser Disclosure Statement to be issued to the
private investors/lenders (as defined) when the broker (MLB) is self-dealing, must be submitted to the DRE in
advance of receipt of such funds as described above (Business and Professions Code Section 10231.2). The
advertising must also meet the requirements imposed pursuant to the regulations of the Real Estate and
Corporations Commissioners (10CCR, Chapter 6, Section 2848 and 10CCR, Chapter 3, Section 260.302).

The reference in this section to the use of funds from pension trusts or plans is not intended to suggest these
sources may be relied upon by MLBs for the funding of loans or the purchase of promissory notes (or
“fractionalized” interests in either) without the prior advice of knowledgeable legal counsel. Transactions with
ERISA regulated pension plans or with IRAs or SEP-IRAs may be prohibited and subject to significant
penalties imposed by applicable federal law.

Disbursing Funds

Unless a lender has given written instructions knowingly authorizing the broker (MLB) to proceed, the broker
may not disburse loan funds until after recording the deed of trust or mortgage which conveys technical legal
title to the security property to a trustee as a principal source of the repayment of the loan. If the lender has
given the broker (MLB) authority to release funds prior to recordation, the securing deed of trust or mortgage
must be recorded, or delivered to the lender with a written recommendation for immediate recordation within
ten days following disbursement of loan funds (Business and Professions Code Sections 10233.2, 10234,
10234.5 and 10 CCR, Chapter 6, Section 2841.5).

The broker (MLB) is similarly responsible for the execution and recordation of the assignment of a deed of
trust or mortgage when the transaction has been negotiated by the broker (MLB). In addition, the broker is
required to deliver or cause to be delivered conformed copies of the deed of trust or mortgage to the investor or
lender within a reasonable amount of time from the date of recording. MLBs may delegate this responsibility
(subject to written confirmation) to the escrow holder or title insurer escrowing or insuring the loan transaction
(Business and Professions Code Section 10234.5). When the investor or lender is a private investor/lender or a
group of private investors/lenders (as defined), the broker (MLB) should not proceed to disburse funds before
recordation of the security instrument/device.

Table Funding

Table funding by a real estate broker (MLB) is unauthorized and in violation of applicable law (Business and
Professions Code Sections 10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5). The only
exemption to the table funding prohibition is found in Section 10234(d). This exemption applies when the
lender is a depository institution or a licensed lender (as defined) and when the security property is other than a
dwelling (i.e., a single family unit in a condominium or cooperative, or any parcel containing residential units
numbering four or less). In addition, if the security property is unimproved, no exemption applies.

Generally, a real estate broker (MLB) may not table fund any residential mortgage loan or a loan secured by
unimproved property regardless of the status of the lender. Commercial loans (other than a residential mortgage
or unimproved land) may be table funded with a lender that either is a depository institution or appropriately
licensed under and pursuant to applicable California law.

The concept of table funding has been driven by depository institutions and licensed lenders as a means of
reducing capital reserves (among other objectives) to support the loans in their portfolio that have been funded
and delivered by MLBs (now also known as MLOs). These institutions and lenders are also concerned about
the contingent liability they incur when selling these loans to the secondary market under terms that include an
obligation to repurchase (in the event of breaches of specified representations and warrantees), and in
connection with servicing agreements when the institutions or lenders retain servicing. Loans delivered by
MLBs to depository institutions and licensed lenders that were table funded were characterized as secondary
market transactions to allow different treatment when disclosing the compensation paid to MLBs/MLOs and to
support how the loan is “booked” as an asset in the records of the depository institutions and of the licensed
lenders. While this concept may function in other states, table funding is contrary to applicable California law.

The Real Estate Law (as well as the Finance Lender Law and the Residential Mortgage Lending Act) prohibits
table funding in California with narrow limited exemptions (Business and Professions Code Sections 10233.2,
10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5; 10CCR, Chapter 3, Section 1460; and Financial Code
Section 50003 (o) and (t)). When an MLB negotiates a loan secured by a deed of trust or mortgage on real
property, the broker is to record or cause to be recorded the security instrument/device in the name of the
beneficiary/lender/mortgagee (or an authorized nominee thereof) who shall not be the licensee or the licensee’s
nominee. This also applies when the MLB sells, endorses, or assigns the promissory note and assigns the deed
of trust or mortgage securing the loan, i.e., the assignee cannot be the licensee or the licensee’s nominee
(Business and Professions Code Sections 10234 and 10234.5 and 10 CCR, Chapter 6, 2841.5).

To avoid unauthorized table funding, the originator of the loan (e.g., an MLB/MLO) must use its “own funds”,
as defined. Further, the originator must approve the loan and must be the named payee on the promissory note
and identified in the deed of trust or mortgage as the named beneficiary/lender/mortgagee. Delegation of
underwriting the loan transaction to a lawfully authorized person is acceptable; however, the creditor/lender
must approve the loan transaction, which approval cannot be delegated under applicable law.

California law generally defines “own funds” to mean the capital of the broker (MLB) or of the creditor/lender
or funds obtained from an independent line of credit as long as the obligations of the line appear as a debt on
the financial statement of the broker (MLB) or of the creditor/lender. The use of “own funds” (as defined) is
required to perform as a creditor/lender in the loan transaction. It is brokering, not lending, to fund loans
relying on the advance commitment to or the actual purchase of the loan at the close of the loan escrow by a
creditor/lender (including when the funds are drawn down for each loan on an individual or loan-by-loan
basis). The use of “own funds” (as defined), loan approval, and naming the creditor/lender as the initial payee
in the promissory note and as the beneficiary/lender/mortgagee in the deed of trust or mortgage will collectively

constitute evidence of the identity of the actual lender (Business and Professions Code Sections 10131.1,
10233.2, 10234, 10234.5 and 10 CCR, Chapter 6, Section 2841.5; 10CCR, Chapter 3, Section 1460; Financial
Code Section 50003 (o) and (t); and 24CFR Parts 3500 et seq.).

Servicing - Broker Advances

A real estate broker (MLB) servicing a promissory note may advance his or her own funds to authorized third
parties to protect the security of the loan being serviced, including an advance to pay debt service on a senior
promissory note and deed of trust or mortgage secured by the same real property. If the MLB does advance
funds for taxes, hazard insurance, or debt service on a senior loan secured by the same real property, the broker
must, within ten (10) days, provide written notice of the advance to the beneficiary/holder of the promissory
note/loan being serviced (Business and Professions Code Section 10233.1).

Retention of Funds

If a broker receives funds from the obligor/borrower in payment of a promissory note, as is ordinarily the case
when servicing the promissory note, the broker may not retain the funds for more than 25 days without written
authorization from the obligee/lender to whom the funds are to be disbursed. The authorization from the
obligee/lender may not provide for payment of interest to the broker on funds retained by the broker (MLB).
Moreover, the agreement between the real estate broker (MLB) and the obligee/lender or obligor/borrower
authorizing the broker to service the instrument must be in writing. This 25 day distribution period also applies
to the receipt of payoff funds due to private investors/lenders (Business and Professions Code Section 10231.1).

As previously mentioned, an MLB may not accept loan funds except for a specific loan transaction or for the
purchase of a specific promissory note or of “fractionalized” interests in either, unless authorized through a
qualified and registered offering resulting in a permit being issued by the DOC (Business and Professions Code
Section 10231 and Corporations Code Section 25000 et seq.).

Advertising

Business and Professions Code Section 10235 describes as unlawful false, misleading, or deceptive advertising
by a real estate licensees (MLBs) engaged in the business of brokering loans or in the sale or assignment of
existing promissory notes and deeds of trust or mortgages. These limitations apply whether the advertising
occurs through printing, display, publishing, or otherwise distributing through print or electronic media; or
telecasting or broadcasting, or in any other manner. An advertisement cannot imply a yield or return on
promissory notes different from the interest rates set forth in the notes themselves, unless the advertisement sets
forth both the actual interest rates and the differences (discounts) between the outstanding principal balance of
the promissory notes and the price at which the notes are being offered for sale.

Article 5 also prohibits real estate licensees (MLBs) from offering or advertising any premium, gift, or other
inducement to a prospective promissory note purchaser or lender (private investors/lenders). The Real Estate
Law was amended to allow for inducements made available to prospective borrowers, provided the
inducements are not intended to steer or direct the perspective consumer/borrower to an unsuitable loan
product. No costs or fees may be added or increased to allow for the inducements (Business and Professions
Code Section 10236.1).

Real estate licensees (MLBs) are not to place an advertisement to be disseminated primarily in this state for
loan transactions or for the sale of promissory notes and deeds of trust or mortgages, unless disclosed within the
printed or oral text is the license number of the licensee under which the loan is to be made or arranged or the
promissory note is to be sold, endorsed, or assigned (Business and Professions Code Section 10235.5).

The Real Estate Commissioner’s Regulations implement the statutory provision against false, misleading or
deceptive advertising in areas of mortgage loan brokerage and in the marketing of promissory notes and deeds
of trust or mortgages. As previously mentioned in this Chapter, MLBs must disclose their license status and the
identity of the regulatory agency in advertisements (regardless of media) concerning contemplated loan
transactions or for the intended purchase and sale or assignments of promissory notes and deeds of trust or
mortgages.

A disclosure of “Real Estate Broker, CA. Dept. of Real Estate” in mortgage loan advertising complies with
applicable law (10CCR, Chapter 6, Sections 2847.3 and 2848). The broker (MLB) license identification
number must also be included in the advertisement (Business and Professions Code Section 10236.4(a) and

(b)). When MLBs engage in transactions subject to the Corporate Securities Law of 1968 and the Corporations
Commissioner’s Regulations pertaining thereto, the advertising regulations of this law must be complied with
(Corporations Code Section 25300, 25301, and 25302, and 10CCR, Chapter 3, Section 260.302).

Commissioner’s Regulations

Real estate licensees active in the mortgage loan business (MLBs) should be familiar with the Real Estate
Commissioner’s Regulations set forth in 10CCR, Chapter 6, commencing with Section 2725. Among the most
important are Sections 2830.1 et seq. (trust fund accounts/handling); 2840 et seq. (approved borrower
disclosure statements and related loan disclosure requirements); 2844 (lending practices for non-traditional
mortgage products); 2845 (interpretative opinion request); 2846 (approved lender/purchaser disclosure
statements); 2846.5 (report of annual trust fund accounts review); 2846.7 and 2846.8 (filing of annual trust
account and quarterly trust fund reports); 2847, 2847.3 and 2848 (advertising requirements, including voluntary
submissions); 2849.01, 2849.1 (annual Business Activities Report format and reporting transactions pending at
close of the MLB’s fiscal year); and 2970 and 2972 (advance fee agreements and related accounting
requirements).

Article 6 – “Multi-Lender” Loans

Claim of Qualification by Exemption Rather than Qualifying by Registration of Securities

For the purposes of this section, the term “purchaser” is intended to identify persons who fund loans (typically
private investors/lenders, as defined) secured directly by real property or “fractionalized” interests therein or
who purchase promissory notes or fractionalized interests therein. The rules discussed under “Article 5”
generally apply to promissory notes secured by deeds of trust or mortgages on real property where the
beneficiary/lender mortgagee is a private investor/lender or promissory note purchaser. However, when the loan
is funded or the promissory note is purchased (including “fractionalized” interests in either) by more than one
private investor/lender (as defined), the loan transaction is known as “multi-lender” which describes the use of
funds from multiple beneficiaries/lenders/mortgagees.

As previously described in this Chapter, these transactions are known as “multi-lender”, “fractionalized” loans,
or “fractionalized” promissory notes. By way of review, Corporations Code Section 25019 describes notes as
securities (unless subject to a specific exemption pursuant to applicable law, including a statutory/regulatory
scheme established for this purpose). “Multi-lender” notes are securities regulated under the Real Estate Law
and the Corporate Securities Law of 1968 and the respective Commissioners’ regulations pertaining thereto.

To offer interests in a loan or a promissory note to more than one private investor/lender (as defined), the
broker (MLB) must either qualify the offering through an exemption or by registration resulting in the receipt
of a permit from the DOC, as defined (Corporations Code Sections 25019, 25100(p), 25102(e), 25102(f),
25102(n), 25102.5, and 25110 et seq. (among others). As previously discussed, the securities specific
exemption for “multi-lender” loan transactions and promissory notes is set forth in Article 6 of the Business and
Professions Code, commencing with Section 10237 and in accordance with Corporations Code Section
25102.5.

Notification to the Department of Real Estate

The real estate broker (MLB) must notify the DRE within 30 days after the first “multi-lender” transaction and
within 30 days of any material change, as defined in applicable law (Business and Professions Code Section
10238(a) and 10CCR, Chapter 6, Section 2846.1). The purpose of the notification is to inform the Real Estate
Commissioner that the broker (MLB) is engaging in “multi-lender” transactions and to inform the
Commissioner of various material facts regarding such broker’s business plan/model.

A broker (MLB) or other person (including entities) lawfully entitled to become the servicing agent for holders
of “fractionalized” promissory notes originated, sold, endorsed, or assigned pursuant to Article 6 must also
provide the DRE with notification no later than 30 days after achieving certain requirements pursuant to
applicable law. These requirements include, servicing loans for which payments are due during any period of
three consecutive months in the aggregate that exceeds $125,000 or the number of private investors/lenders
(including all persons) entitled to receive payments exceeds 120 (Business and Professions Code Section
10238(b)).

Advertising for Private Investors/Lenders

As previously discussed, all advertising soliciting private investors/lenders, note purchasers, or borrowers must
comply with the Real Estate Law and the Corporate Securities Law of 1968 and the respective Commissioner’s
Regulations pertaining thereto (Business and Professions Code 10238(c); 10CCR, Chapter 6, Section 2848; and
10CCR, Chapter 3, Section 260.302).

No expression or implication can be included or made in an advertisement that a contemplated transaction
subject to Article 6 of the Real Estate Law has received any approval by the DRE or the DOC. The same
standard applies to any offering of securities issued by a real estate broker (MLB), whether qualified by
exemption or registration, as defined.

Property Securing the Loan

The real property securing the loan must be located in California and “fractionalized” promissory notes and
deeds of trust or mortgages cannot by their terms be subject to subordination to any subsequently created deed
of trust or mortgage against the same security property. Further, the “fractionalized” promissory notes and
deeds of trust and mortgages may not be promotional notes, as defined (Business and Professions Code Section
10238, 10238(d)(1) and (d)(2) and Corporations Code Section 25000 et seq. and Corporations Commissioner’s
regulations pertaining thereto).

Promotional notes are secured by liens (deeds of trusts or mortgages) on separate parcels of real property in one
subdivision or in contiguous subdivisions (or in units or phases of either). Promotional notes are defined to
mean promissory notes secured by liens on real property executed on unimproved real property, or executed
after construction of an improvement on the security real property, but before the first purchase of the property
as so improved, or executed as a means of financing the first purchase of the property as so improved; that is
subordinate (or by its terms may become subordinate) to any other deed of trust or mortgage on the security
property (as defined).

Real estate brokers (MLBs) may not issue promotional notes, as defined (in a subdivision or contiguous
subdivisions, or in phases or units thereof) without qualifying the offering with the DOC, i.e., registering when
obtaining a permit from the DOC, unless an exclusion from the definition of promotional notes applies to the
transaction. Pursuant to Business and Professions Code Section 10238(d)(1)(2),the definition of promotional
notes does not include:

1. A promissory note and deed of trust or mortgage that was executed in excess of three years prior to
being offered for sale; or,

2. A promissory note secured by a first deed of trust or mortgage on real property in a subdivision (as
defined) that evidences a bona fide loan made in connection with the financing of the usual cost of the
development of a residential, commercial or industrial building, or of buildings to be constructed on
the security property under a written agreement providing for the disbursement of the loan funds as
costs are incurred or in relation to the progress of the work; and further providing, for title insurance
“ensuring” (insuring) the priority of the security instrument/device against mechanics’ and
materialmen’s liens, or regarding the final disbursement of at least 10% of the loan funds after the
expiration of the period for the filing of mechanics’ or materialmen’s liens.

It should be noted that the second exclusion does not extend to security property consisting of unimproved land
or land that is improved with offsite (including backbone) or onsite improvements. The second exclusion
contemplates vertical construction with construction loan agreements entered into describing the manner in
which disbursements are to occur and with title insurance coverage insuring the continued priority of the deeds
of trust or mortgages (security devices/instruments) against mechanic’s and materialmen’s liens (Business and
Professions Code Section 10238(d)(1) and(2) and Corporations Code Section 25000 et seq.; and the respective
Commissioners’ regulations pertaining thereto).

“Fractionalized” promissory notes and deeds of trust or mortgages must be secured directly by real property. No
collateral assignments (hypothecations) of “fractionalized” promissory notes and security devices/instruments
are allowed, i.e., hypothecation through collateral assignments of “fractionalized” notes would cause the loss of
the “quasi-private placement” exemption from qualification of the securities by registration. This and other

deviations from the standards required in the securities specific statutory and regulatory scheme would be
violations of the “quasi-private placement” exemption (Business and Professions Code Section 10237 et seq.
and Corporations Code Section 25102.5).

Practitioners should not engage in promotional notes (as defined) or in hypothecations through collateral
assignments of promissory notes and deeds of trust or mortgages (whether or not “fractionalized”) without the
prior advice of knowledgeable securities legal counsel.

The Broker as Issuer and Related Self-Dealing Limitations

The securities represented by “fractionalized” promissory notes and deeds of trusts or mortgages must be issued
by and sold through a licensed real estate broker (MLB) who is acting in the capacity of an agent or of a
principal in the secured transaction and in the three roles previously described in this Chapter in the context of
the securities being issued (Business and Professions Code Sections 10131.3, 10237 and 10238(e), and the Real
Estate Commissioner’s regulations pertaining thereto; Corporations Code Sections 25019, 25100(e) and 25206,
and the Corporations Commissioner’s regulations pertaining thereto, including 10 CCR, Chapter 3, Section
260.115 and 260.204.1, among others).

No self-dealing (as described in Business and Professions Code Section 10231.2) is allowed, except under two
fact situations described in applicable law, provided the interests of the broker (MLB) or the affiliate of the
broker (if any) is first disclosed to the private investors/lenders, and the disclosure includes under what
circumstances the MLB or the affiliates acquired their interests in the contemplated transaction. The two
exclusions are generally described below:

A transaction in which the broker (MLB) or an affiliate of the broker is acquiring the promissory note and
security devices/instruments or the security property that are under foreclosure (including at the foreclosure
trustee’s sale) of a deed of trust or mortgage for which the broker (MLB) is the servicing agent, or the loan
being foreclosed is evidenced by a promissory note and deed of trust or mortgage that was sold, endorsed,
assigned, or exchanged to the present holder(s) thereof by or through the MLB; or,

A transaction in which the broker or an affiliate of the broker (MLB) is re-selling from inventory the real
property acquired by the holder or holders through foreclosure, provided that the broker (MLB) is the servicing
agent of the loan that was foreclosed or the promissory note and deed of trust or mortgage evidencing and
securing the foreclosed loan was sold, endorsed, assigned, or exchanged by or through the MLB to the holder
or holders thereof.

Applying the language of the two exclusions describing when a broker (MLB) may self-deal in the context of a
“multi-lender” transaction or in any other offering of securities (whether qualified by exemption or registration)
requires the advice of knowledgeable securities legal counsel.

The Purchasers

The note cannot be sold to more than 10 persons, as defined, who must meet certain income or net worth
requirements, i.e., the private investors/lenders must be suitable for the contemplated transaction. The
investment cannot exceed 10% of the net worth of the private investors/lenders (the purchaser’s net worth),
exclusive of home, furnishings, and automobile; or the investment cannot exceed 10% of the adjusted gross
income of the private investors/lenders (the purchaser’s adjusted gross income).

The foregoing thresholds of 10% of the net worth or 10% of the adjusted gross income apply whether the
investment arises from the funding of a “fractionalized” interest in the promissory note and deed of trust or
mortgage, or from the purchase of the promissory note or interests therein as an existing asset. The suitability of
the private investors/lenders must be considered for the specific transaction and the “thresholds” may not be
exclusively relied upon for this purpose (Business and Professions Code Section 10238(f) and the Corporate
Securities Law of 1968 and the Corporations Commissioner’s regulations pertaining thereto).

The Interests

The interests of each private investor/lender (purchaser) in a “fractionalized” loan or promissory note must be
identical in the underlying terms. The terms of the investment representing a “fractionalized” interest in a loan
or promissory note directly secured by a deed of trust or mortgage on real property must be the same among the

private investors/lenders. This includes the interest rate, the servicing fees, and how and to whom the late
charges and prepayment penalty fees are to be distributed, among others.

Notwithstanding the foregoing, private investors/lenders may invest distinguishable amounts resulting in
different percentages of undivided or “fractionalized” interests received in the promissory note and deed of
trust or mortgage (security device/instrument). No stripping of principal or interest amounts (including but not
limited to income streams or yield spreads) may occur and a private investor/lender may not receive any of the
benefits inuring to the beneficiary/lender/mortgagee identified as the initial payee/lender or the endorsee or
assignee thereof in the promissory note and deed of trust or mortgage without receiving and holding a ratable
“fractionalized” interest as the evidence of ownership as the holder or an undivided interest in a promissory
note and deed of trust or mortgage.

Private investors/lenders acquiring interests in promissory notes and deeds of trust or mortgages through
mortgage brokers (MLBs) may not evidence such interests through participation certificates or other forms of
agreements or contracts. Rather, the interest must be evidence by ratable “fractionalized” assignments in the
promissory notes and deeds of trust or mortgages (Corporations Code Section 25100(s).

When a private investor/lender purchases a “fractionalized” interest in an existing promissory note and deed of
trust or mortgage from the holder of the interest, the acquisition price may vary to reflect the market price of the
interest purchased at the time of purchase. This means the benefits inuring to the purchasing private
investor/lender must be identical to the other holders of interests in the “fractionalized” promissory note and
deed of trust or mortgage predicated on a ratable assignment of the undivided interest purchased. For example,
when considering the purchase of an interest in an existing “fractionalized” promissory note and deed of trust
or mortgage, the interest rate of the promissory note, the disposition of late payment charges and prepayment
penalty fees, and the servicing fees must be identical among the private investors/lenders who are the holders
subject to ratable assignment of the foregoing based upon the undivided interests of each holder. The
prohibition regarding principal and interest amounts described in the previous paragraph will still apply
(Business and Professions Code Section 10238(g)).

The applicable law controlling the benefits inuring to private investor/lenders holding “fractionalized” interests
in promissory notes and deeds of trust or mortgage is similar to the meaning applied by the depository
institutions and licensed lenders to the term “pari passu”. However, the distinction between the use of this term
by depository institutions and licensed lenders as compared to MLBs issuing securities to private
investors/lenders is that private investors/lenders do not qualify as investors in transactions where the interests
purchased are participations in the form of certificates or otherwise by agreement or contract in pools of
mortgage loans.

Such investments are limited to depository institutions and other qualified investment buyers (QIBs) who must
meet the predicate qualifications required under Regulation A of Section 4(2) of the Securities and Exchange
Act of 1933 in addition to the Corporate Securities Law of 1968 and the Corporations Commissioner’s
regulations pertaining thereto (15 USC, Chapter 2A, Section 77d and 17 CFR, Chapter II, Section 230.114A,
among others; and Corporations Code Section 25100(s)).

Loan-to-Value Ratios, Appraisals, and Construction and Rehabilitation Loans

Article 6 imposes certain loan-to-value limitations on “fractionalized” loan transactions depending on the type
of the security real property. In some limited circumstances, the statutory loan-to-value limits may be exceeded
if the broker (MLB) deems it to be reasonable and prudent. In such event, the broker (MLB) must include
within the transaction file the written justification for and the evidence in support to exceed the statutory loan-
to-value ratio limits.

Notwithstanding the foregoing, the loan-to-value ratios may not exceed (together with the unpaid principal
balance of any other encumbrance on the security property that is senior to the subject loan) 80% of the current
fair market value of the security real property, as improved, or 50% of the current fair market value of the
unimproved security real property. When the security property is a single family residentially zoned lot or
parcel that has installed offsite improvements (including drainage, curbs, gutters, sidewalks, paved roads, and
utilities as mandated by the local political subdivision having jurisdiction over the lot or parcel), the maximum

loan-to-value ratio is 65% of the current fair market value (Business and Professions Code Section
10238(h)(1)(2)).

The broker (MLB) must advise the private investors/lenders or promissory note purchasers of their right to
receive a copy of an independent appraisal report completed by a qualified appraiser, or the MLB’s evaluation
of the fair market value of the security real property (if the private investors/lenders have first expressly waived
in writing on a case-by-case basis the independent appraisal report). The evaluation of the MLB may not be
delegated to another broker and must include the objective data upon which the MLB relied in offering an
opinion of value, i.e., no “bald” assertions. Further, the MLB must be qualified by knowledge, experience and
training to undertake the valuation of the specific security real property at issue (Business and Professions Code
Sections 10232.4, 10232.5, 10232.6, 10238(h)(3), 10241.3, 11302(b) and 11423).

For vertical construction or rehabilitation loans as authorized by Article 6, the fair market value of the intended
security property must be estimated by an independent appraiser who is properly qualified for the assignment
pursuant to a license or certification issued by the Office of Real Estate Appraisers (OREA). The appraisal
report must be completed in compliance with the Uniform Standards of Professional Appraisal Practice
(USPAP). These standards generally include an “as is” (current) and an “as completed” (future) estimate of fair
market value for the intended security real property.

When the loan being made or arranged relies on a loan-to-value ratio based on the “as completed” or future
value of the security real property, a significant number of safe guards must be operative in the contemplated
loan transaction, including the aforementioned appraisal standards incorporating USPAP and the use of an
appraiser appropriately qualified by license or certification through OREA. Guidance describing the appraisal
process to be accomplished, including the approaches, methods and techniques to be applied by the appraiser in
arriving at an “as completed” or future value is available in the text published by the Appraisal Institute
entitled, “The Appraisal of Real Estate” (13th Edition). The safe guards otherwise include:

1. An independent neutral escrow holder to be used for all deposits and disbursements (e.g., a joint
control agent authorized pursuant to Financial Code Section 17005.1);

2. The loan is to be fully funded, with the entire loan amount deposited in any neutral escrow prior to
recording the deed or deeds of trust or mortgage or mortgages;

3. A comprehensive, detailed, draw schedule is to be used to ensure proper and timely disbursements to
allow for the completion of the project;

4. The disbursement draws from the escrow account are based on inspections by an independent
qualified person who certifies that the work completed to the date of the draw meets the related codes
and applicable standards and that the draws were made in accordance with the construction contract,
including the agreed upon draw schedule incorporated in the Construction Loan Agreement;

5. The independent qualified person authorized to make inspections and certified the work completed
may not be a person who is an employee, agent or affiliate of the broker (MLB) and is to be licensed
as an architect, a structural engineer, or general contractor, or an active local building inspector
performing in his or her official capacity to make such inspections (as authorized by the local building
official);

6. The loan transaction is properly documented, including the holders of the beneficial interests in the
promissory notes and deeds of trust or mortgages evidencing the debt and securing the construction or
rehabilitation loan, agreeing to be governed for actions taken by Civil Code Section 2941.9, and the
documentation shall include a detailed description of the actions that may be taken in event of failure
to complete the project (whether as a result of default, insufficiency of funds or other causes); and,

7. The entire amount of the loan does not exceed $2,500,000 (Business and Professions Code Section
10230(h)(4)).

If the loan is secured by more than one real property, the maximum loan-to-value percentages of each type of
property must be met in accordance with the statutory limits imposed (Business and Professions Code Section
10238(h)(1)(2) and (5)). “Multi-lender” notes if secured by more than one real property in a subdivision (as
defined) require the use of one promissory note and deed of trust or mortgage recorded as a blanket
encumbrance with appropriate release clauses.

Terms of Default and Foreclosure

As previously discussed, the documentation of the transaction must require:

1. A default upon any interest in or in connection with a promissory note and deed of trust or mortgage is
a default on all interests or promissory notes and deeds of trust or mortgages evidencing and securing
the debt(s) or loan(s) for the subject transactions; and,

2. The holders of more than 50% of the beneficial interests (as defined) are entitled to govern the actions
binding all of the holders of the interests in the promissory notes and deeds of trust or mortgages in
accordance with applicable law in the event of default, the pursuit of a foreclosure (whether judicial or
non-judicial), or for other matters that may require direction or approval of the holders.

The majority action standard to be accomplished in what has been described as a majority action affidavit
specifically excludes the real estate broker (MLB) or any affiliate of the broker who has issued or is servicing
the loan transaction for determining the majority (defined to be more than 50% of the holders). This exclusion
extends to an MLB who is servicing the loan who may not be an affiliate of the real estate broker (MLB) that
issued the security (Business and Professions Code Section 10238(i), Civil Code Section 2941.9, and
Corporations Code Section 25013).

Receipt of Funds, Disclosures, Trust Accounts and CPA Review

As previously discussed, the broker (MLB) must present to private investors/lenders a specific loan transaction
or a specific promissory note in which the requested deed of trust or mortgage investment will be made. Prior to
accepting funds from private investors/lenders for a specific transaction (as defined), the MLB must disclose
the relevant material facts and investment risks in connection with the contemplated investment. These
disclosures typically begin with a summary of the terms of the specific loan transaction or of the promissory
note and deed of trust or mortgage in which the funds of the private investors/lenders will be invested.

Should these private investors/lenders express interest in the summarized and described deed of trust or
mortgage investment opportunity (whether to fund a loan or to purchase a promissory note or an interest
therein), a lender/purchaser disclosure statement (as previously discussed in this Chapter) must be completed
and delivered by the MLB before accepting any investment capital/funds. The DRE publishes four
lender/purchaser disclosure statements for use by MLBs for carrying out the disclosure objective. MLBs are not
entitled to construct their own disclosure forms and are required to request permission from the DRE to rely on
forms other than the specific published forms. The request must be made on behalf of at least 25 real estate
brokers (MLBs) who have qualified as “threshold” brokers in accordance with applicable law (Business and
Professions Code Section 10232(e) and 10232.5(a)(b); and 10CCR, Chapter 6, Section 2846).

The Lender/Purchaser Disclosure Statements published by the DRE are intended for use in distinguishable
transactions (as defined) and are numbered 851A, 851B, 851C and 851D. Form 851A is for loan origination
(whether funded by a single private investor or “fractionalized”); form 851B is for the sale of an existing
promissory note and deed of trust or mortgage or a “fractionalized” interest therein that was not originated by
or through the MLB; form 851C is for hypothecations of an existing promissory note and deed of trust or
mortgage (which are prohibited in “multi-lender” transactions); and, 851D is when the deed of trust or
mortgage describes as security for the repayment of the loan more than one real property (cross-
collateralization or blanket encumbrances). The MLB may add addendums to these required Lender/Purchaser
Disclosure Statements to ensure the relevant material facts and investment risks are disclosed fully. If more than
one real property secures the loan, the broker must disclose to the private investors/lenders the risks associated
when securing the loan by multiple properties to the lender or note purchaser (Business and Professions Code
Section 10238(l) and form 851D).

All funds received from private investors/lenders are trust funds and must be handled in accordance with
Business and Professions Code Sections 10145 and the Commissioner’s applicable regulations, 10CCR,
Chapter 6, Section 2830.1 et seq. The MLB who issued the securities or who is performing as the servicing
agent in “multi-lender” transactions must file CPA-prepared quarterly and annual reports (if the payments due
in any 3-month period exceed $125,000 or the number of persons entitled to the payments exceeds 120).

The Article 6 reporting criteria for “multi-lender” transactions differs from the Article 5 reporting criteria when
reporting loan-servicing activities. The Article 6 criteria applies to payments due and the Article 5 criteria
applies to payments collected. The broker (MLB) engaged in “multi-lender” transactions must also submit an
annual report of business activities to the DRE (Business and Professions Code Sections 10238(j), (o), (p)).

Loan Servicing

To service a loan on behalf of the holder or holders, a written servicing agreement is required (Business and
Professions Code Section 10233 and 10238(k)). The servicing agreement is a component of the investment
contract relationship among the private investors/lenders and the MLB. This investment contract relationship is
applicable whether the loans or promissory notes and deeds of trust or mortgages being serviced are “whole
notes” (Corporations Code Section 25100(p)), “multi-lender” notes (Business and Professions Code Section
10237 et seq., and Corporations Code Section 25102.5), an offering qualified by exemption (Corporations Code
Sections 25102(e), (f), (i) or (n)), or an offering qualified by registration (Corporations Code Section 25110 et
seq.).

The tests to apply for the purposes of establishing an “investment contract” include:

1. An investment of money due to;

2. An expectation of profits arising from;

3. A common enterprise; and,

4. Which depends solely on the essential management efforts of a promoter or third party.

The MLB is the promoter or third party whose management efforts are essential in each of the scenarios
described above, unless the “whole note” (loans made by one private investor/lender, as defined) is neither
underwritten nor serviced by the MLB (Securities and Exchange Comm. v. W. J. Howey Co., 328 U.S. 293
(1946) and Securities and Exchange Comm. v. Glenn W. Turner Enterprises, Inc., et al., No., 474 F.2d 476(9th
Cir.1973)). Under the Real Estate Law, loan servicing on behalf of another or others for compensation or
expectation of compensation (regardless of form or time of payment), requires a real estate broker’s license
unless the person or entity is exempt from such licensure (Business and Professions Code Sections 10131(d),
10133, and 10133.1).

The payments received on the promissory notes and deeds of trusts or mortgages or interests therein must be
transmitted pro-rata to the owners or holders of the promissory notes (i.e., ratably according to their respective
interests) within 25 days of receipt of the payments by the servicing agent. The loan-servicing agent (MLB)
must file a request for a notice of default upon any prior encumbrances and promptly notify the promissory note
owners (holders) of any notice of default (Business and Professions Code Sections 10233 and 10238(k)).

Identities of the Purchasers

Upon request, the broker (MLB) as the issuer or the servicing agent must give private investors/lenders
(whether holders of “fractionalized” interests in loans evidenced by promissory notes and secured by deeds of
trust or mortgages or purchasers of promissory notes or interests in either), the names and addresses of the
purchasers of the interests (Business and Professions Code Section 10238(m)). The MLB must keep accurate
records of the names and addresses and other relevant information on private investors/lenders whether
participating in a “multi-lender” transaction (a “quasi-private placement”), another form of private placement
through an offering qualified by exemption, or an offering qualified by registration.

No Option to Purchase

The broker (MLB) cannot have any option right or an agreement that grants a future right to acquire (including
re-purchase) the “fractionalized” interests of the private investors/lenders or to acquire the security real
property, except as authorized by applicable law (Business and Professions Code Section 10238(n)). As
previously discussed, the broker (MLB) may acquire the interests of the private investors/lenders in the context
of a foreclosure or in connection with the security real property after the foreclosure has occurred (Business and
Professions Code Section 10238(e)).

The MLB may acquire the interests of private investors/lenders (as the issuer of the securities or as the
servicing agent), provided the concurrent consent of the private investor/lender is obtained. Pursuant to the
foregoing, the MLB may acquire such interests whether the interests are in “fractionalized” promissory notes
and deeds of trust or mortgages or in the security real property held by the private investor/lender subsequent to
a foreclosure. When the “fractionalized” promissory note and deed of trust or mortgage represents securities
issued pursuant to the “multi-lender” statutory exemption, or is issued through an offering qualified by
exemption (as defined), the interests acquired by the MLB may not be re-sold in violation of applicable law
(Business and Professions Code Section 10238(n) and Corporation Code Section 25104(a)).

Conclusion

Brokers (MLBs) must use an abundance of caution when engaging in “multi-lender” transactions, a statutory
“quasi-private placement” exemption from qualification of the securities granted pursuant to the Real Estate
Law and the Real Estate Commissioner’s Regulations pertaining thereto, and the Corporate Securities Law of
1968 and the Corporations Commissioners regulations pertaining thereto (Business and Professions Code
Section 10237 et seq. and Corporations Code Section 25102.5, among others).

This exemption is securities specific and any violation of the provisions of the exemption from otherwise
qualifying by registration may result in a violation of the Real Estate Law and in a violation of the Corporate
Securities Law of 1968, including the respective Commissioners’ Regulations pertaining to each (Business and
Professions Code Sections 10131.3, 10177(n) and 10237 et seq., and the applicable regulations of the Real
Estate Commissioner, among others; and Corporations Code Sections 25019, 25102.5 and 25206, and the
applicable Regulations of the Corporations Commissioner’s, among others).

Violations of the securities law are subject to criminal prosecution. Therefore, it is prudent and recommended
that MLBs seek the advice of knowledgeable securities legal counsel prior to engaging in “multi-lender”
transactions qualified by statutory exemption, or transactions involving interests in real property (whether
equitable or fee or a mortgage interest) otherwise qualified by exemption or qualified by registration.