LOANS AND LIENS AND. . .WHAT CAN GO WRONG HERE? PROTECTING A LENDER’S COLLATERAL POSITION UNDER THE UCC – ONCE AGAIN THE DEVIL IS IN THE DETAILS

 

The lender gets loan documents signed by the borrower and gets collateral to secure the debt – that is, a lien on the borrower’s property. It sounds easy and familiar. So what can go wrong here? The progression of cases interpreting the Uniform Commercial Code (UCC) provides insight into the mistakes, large and small, that can create unexpected exposure for lenders and surprise defenses for borrowers. Earlier this year two new cases shed additional light on this question. This article takes up the first of these.

Situation – A Lien on an LLC

The case involved an LLC membership interest offered as collateral for a commercial loan. 11 East 36 th, LLC (“36 LLC”) was the sole member of Morgan Lofts, LLC (“Lofts LLC”), which owned numerous units in a building. Both entities along with a third entity (the Borrower in this situation) were controlled by common family interests. As security for a loan to Borrower, the controlling family agreed to have 36 LLC pledge its sole membership interest in Lofts LLC.

When the transaction was documented, the pledge agreement granted a lien in favor of the lender in the Lofts LLC membership interest held by 36 LLC. The UCC-1, however, described the collateral as specific units in the building that were owned by Lofts LLC.

Bankruptcies were subsequently filed by 36 LLC and Lofts LLC and the lender’s security interest was challenged. The court held that the lender was unsecured as its UCC collateral description incorrectly described the collateral as the real estate owned by Lofts LLC and not the membership interest of 36 LLC in Lofts LLC. Although the lender had its security interest correctly described in the loan papers, it did not really matter because the UCC-1 had it all wrong. The court explained that 36 LLC had no interest at all in the real estate units owned by Lofts LLC; rather, its lien was on the membership interest and it never perfected that security interest. Accordingly, the lender was a mere unsecured creditor in the bankruptcy. In re 11 East 36 th, LLC, 2016 WL 1117588 (S.D.N.Y. March 21, 2016). The takeaway? A security interest in an LLC membership interest is very different than a security interest in the assets actually held by that LLC. The lesson is clear: make sure you accurately describe the collateral in the UCC-1 to properly perfect your interest in that collateral.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Lenders and Licensing and Exemptions: The World According to the California Finance Lenders Law

By: Jack Easterbrook

Many of our clients, at one time or another, get involved in private loan activities in California as a lender. It may be to help finance a business, purchase or improve real estate around San Jose, Silicon Valley or elsewhere in California, or just to provide funds for a family member. Although most lending has been and continues to be done by regulated financial institutions, opportunities abound for private lenders and many people are attracted to the market, whether for economic gain, to participate in a start-up idea or to just help out family or friends. The purpose of this article is to alert private lenders that California has established licensing rules to govern this lending activity, and to protect them from the risk of fines or even criminal charges for failing to follow these rules.

The California Finance Lenders Law (CFLL) is the name commonly given to the body of statutes imbedded in the California Finance Code addressing most lending activity in California. The CFLL governs the activities of both brokers and lenders engaged in the business of negotiating or making “commercial loans” or “consumer loans,” which broadly covers most lending activity in the state. Essentially, the CFLL requires any person participating as a lender or broker of commercial or consumer loans in California to obtain a license from the California Commissioner of Business Oversight unless the person qualifies for an exemption. Getting the license can easily take over six months to complete and involves a number of requirements, such as making numerous disclosures, paying fees, obtaining a surety bond and demonstrating financial wherewithal. Violations may result in fines of up to $10,000 and possibly imprisonment.

The CFLL, as mentioned, contains numerous exemptions to the licensing requirement and these can become very important to persons or entities involved in lending activity. Banks, credit unions and most institutional lenders qualify for an exemption. Exemptions exist, as well, for many other persons and entities involved in certain kinds of loans. A few of the most significant exemptions are: (a) loans by persons or entities making no more than five commercial loans in a twelve month period so long as such loans are “incidental” to the primary business of the person seeking the exemption; (b) loans made or arranged by licensed real estate brokers when the loan is secured by a lien on real property; and (c) commercial bridge loans made by venture capital companies to an operating company. Numerous other unique exemptions also exist.

The situation can be complicated by the use of intermediaries or separate business entities as the actual lender. The lending entity itself must qualify for the exemption. For example, a loan may be an incidental activity for an individual but not for an LLC actually making the loan.

If you are entering into a transaction in California in which you will be lending money, whether to an entity or a person, one item of due diligence not to overlook is whether you, or the affiliated entity in which you have an interest (if it is going to act as the lender) qualify for an exemption under the California Lender Finance Law. If you identify early the fact that the lender is not licensed and the proposed loan may not qualify for an exemption, it may be possible to develop a way of accomplishing your business objectives by revising some aspect of the proposed deal. Alternatively, the licensing requirement can be included in the checklist and factored into the timeline for making the loan. In any event, a private lender will want to handle the matter in a fashion that eliminates the risk of fines or worse.

Loans With High Rates of Interest – Be Careful About Usury

By: Serge Filatov

As a corporate attorney here in Silicon Vall

ey and San Jose, I have numerous clients who need help documenting loan transactions and promissory notes . These clients may be taking on debt or providing a loan to a third party. One area of law that clients are not always familiar with is usury law. The California constitution protects individual borrowers from usury, which in simple terms is the lending of money at very high rates of interest. With some notable exceptions, the general rule is that loans cannot have an interest rate that exceeds 10% per year.

How is it then that your credit card company can charge over 10% interest on your

personal card? The answer to that is that there are numerous exceptions

to the general usury rule. In fact, the general rule is riddled with exceptions that are spread out between sections of the California civil, commercial, corporate, and financial code. Often, an exception concerns a specific item that the legislature was concerned with at the time so the exceptions pop up in random places of the California code.

Examples of common exceptions to the rule include California Civil Code Section 1916.1 which states that usury does not apply to loans made or arranged by a licensed California real estate broker, which are secured by liens on real property. Licensed lending institutions such as banks and credit unions are also exempt from usury laws.

Additional common exceptions, at least for the clients that I work with, are (i) loans made to a business that has $2,000,000 or more in assets at the time of the loan or (ii) loans that are for $300,000 or more. In order to qualify for these exceptions, the borrower must meet the following criteria:

  • The borrower cannot be an individual.
  • The lender must have a pre-existing relationship with the borrower.
  • The borrower must reasonably appear to be able to protect its own interests.
  • The loan must not be primarily for personal, family, or household purposes.

What is the big deal about a usurious loan? The lender could forfeit all interest on the entire loan and may have to pay the borrower 3 times the interest paid during the 12 months prior to the filing of a lawsuit. Also, a lender who willfully and maliciously receives interest in violation of usury law can be found guilty of being a loan shark which is a felony punishable by up to 5 years of jail.

Be careful if you are making a loan with a high rate of interest. If you are considering making such a loan, you should consultant with an attorney to confirm that the loan is not usurious.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

The Secret Side of UCC Financing Statements

In my experience representing banks, asset based lenders and private lenders in San Jose and throughout the San Francisco Bay Area, an overriding concern is to make sure that the lender has the ability to go after the collateral if the borrower does not pay for any reason. Accordingly, a lender, secured creditor or factor taking collateral for a loan* instinctively knows that you need to file a UCC-1 financing statement as part of the transaction. From the earliest days of training, it is drilled into most secured lenders that the UCC-1 is one of those items you must have. It “perfects” the lender’s security interest in collateral, which means that it gives your lien priority and makes the lien rights enforceable against third parties, bankruptcy trustees (if it ever came to that) and others.

UCC Filings and Marketing Strategies

One unintended consequence of UCC filings is beginning to come to light. That is, every filing potentially provides the world – meaning competitors – with information about the lender’s activities. The ongoing development of sophisticated databases allows a person so inclined to figure out who a lender is financing – i.e. who it has as its customers. That, of course, has the potential of leading to targeted marketing efforts. The purpose of this article is to point out that this use of a lender’s UCC filings, which is often not much thought about, is becoming more prolific as database analytical tools become more prolific.

Representative Parties

The requirement of filing a UCC-1 financing statement is so fundamental to credit underwriting and the protections it provides are so substantial that it is out of the question for a secured lender, ABL lender or factor to consider going without one. With that strategy effectively off the table, we are seeing the rise of so-called representative parties or third party representatives who insert the representative’s name rather than the actual lender’s name on UCC-1 financing statements in the secured party box. If a representative party has multiple lenders using the service, it effectively disguises the identity of the actual lender. Of course, this disguise comes with a fee!

The legal underpinning for the use of representative parties is found in Section 9502(a)(2) of the California Commercial Code (and similarly numbered sections in other state’s commercial codes). Section 9502 provides that to be “sufficient” or complete, a financing statement must include the debtor’s name, a description of collateral, and the name of the secured party or a representative of the secured party .

You may hear more about use of representative parties, lender fictitious names and other disguising techniques going forward. The reason is straightforward: it is apparently becoming more necessary to foil the attempts of competitors in the marketplace to obtain a lender’s customer list through analysis of the data bases.

*(Note: The UCC filing is used in connection with liens on most business assets, but does not perfect a lender’s security interest in real estate and certain unique types of assets, which are not discussed in this article. )

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.