Promissory notes and real estate securities

The promise and the security

A promissory note is the borrower's written promise to pay a debt. The maker promises payment; the payee is the person to whom payment is promised. Principal, interest, payment dates, and maturity describe the debt. A mortgage or deed of trust is a separate security instrument connecting the debt to real property. Buying a secured note buys a creditor's investment, not ownership of the borrower's home.

An installment note calls for periodic payments. A fully amortizing loan pays off through scheduled principal and interest payments; a balloon leaves a larger final payment. An acceleration clause can make the remaining debt due after a specified default. Negotiability concerns an instrument's legal characteristics, not simply whether someone will buy it. Sale at a discount means a price below the unpaid principal; the investment's yield also depends on payment timing, costs, and actual collection.

Evaluate the investment

Examine the borrower's ability to pay, collateral value, lien priority, payment history, and terms. A junior lien carries the risk that senior claims consume the collateral's value. Fractional interests divide an investment among investors; real property backing does not itself eliminate securities requirements. Particular transactions may qualify for exemptions, so identify the applicable transaction and exemption before applying a requirement.

California investor protections

Under California Business and Professions Code section 10231, absent the specified securities permit authority, accepting investor funds requires a specific authorized loan, contract, or secured note, rather than an unidentified future investment pool. Section 10231.1 limits retention of funds payable under a secured note or sales contract to 25 days unless a written agreement with the purchaser or lender permits otherwise.

Section 10232.4 requires the applicable completed lender or purchaser disclosure as early as practicable before commitment and generally before receipt of funds. The purchaser or lender and the broker, or the broker's salesperson on the broker's behalf, sign it. Give the investor an exact copy and retain the executed statement for three years.

For brokers subject to section 10232.45, suitability requires reasonable efforts to assess understanding, ability to bear economic risk, and fit with investment objectives, portfolio, and finances. Keep the supporting information for at least four years. The approved-questionnaire compliance route requires obtaining it at least two business days and no more than one year before completing each sale and using its answers in the assessment.

For transactions governed by section 10236.7, identify the qualification or exemption provisions in the transaction file and furnish that information to an investor within ten days after receiving the investor's funds. Threshold brokers under section 10232.2 ordinarily file annual reports within 90 days after fiscal year end, subject to an allowed extension. Distinguish these reporting duties from the underlying note's payment terms.