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Local Private Money Investors Get Nailed with Usury Claim or “When is a Broker Not Really a Broker?” or “The Problem with Fractionalized Notes”

Mortgage & Lending Law by Peter N. Brewer, Esq.

In a stunningly horrific recent case against private investors, the California Court of Appeals punishes investors on a multi-lender Note, rewards a borrower in default and allows the true bad actor (the mortgage loan originator) to walk away.

Jim Ward & Associates (sometimes referred to as “JSW”) was a local business based in Mountain View.  Ward held himself out as a private money arranger and brokered a number of loans with local private investors and to local builder/developers.  One of the developers, Creative Ventures, LLC entered into a construction deal with Jim Ward & Associates (referred to in the Court decision as “JWA”) in October of 2003, and borrowed $2M to build Buckmeadow, a residential property in Menlo Park.

Ward brokered the loans for the project, charging 12% interest for the loan, as well taking a broker’s fee of 6%.  The Promissory Note stated that “The loan evidenced by this Note has been arranged by a real estate broker licensed under the laws of the State of California.”

Turns out, JWA did not have a California broker’s license.

You have to wonder how something so small can be so difficult to do right.  Turns out that James S. Ward individually carried a broker’s license.  Also, when JWA, Inc. started out in the 90’s, it appeared to have a corporate license, but that company was merged out of existence in 1997.  No company, no license.  Simple, right?

Well, not exactly.  Ward decided to restart his company and in 2000, a new JWA entity was formed.  This is where things get complicated.  Ward requested a renewal of the license for JWA, Inc., the old company, not the new company.  The DRE issued one for the non-existent company.  Whoops!

The DRE eventually figured out the screw up and audited JWA (the new company), the DRE auditor told JWA’s attorney that JWA was not licensed on October 1, 2003, just one week before JWA closed the loan to Creative Ventures, LLC.

JWA then applied for a license from the DRE…and the DRE filed an accusation (disciplinary proceeding) against Jim Ward and revoked Ward’s license and denied JWA’s application.

This is essentially the equivalent of a get-out-of-jail-free card for the borrowers, because the borrowers now have the defense that the loan was usurious.   Under Article XV, section 1 of the California Constitution, the maximum rate a lender can charge on nonpersonal loans is “the higher of 10 percent or 5 percent plus the Federal Reserve Bank of San Francisco’s rate on the 25th day of the month preceding the date the agreement was contracted.”  The exception is if the loan is arranged by a licensed broker and if the loan is secured by real property (personal property loans are governed differently).

Interest rates having been so low for the last decade, 10% is essentially the cap for a non-broker arranged loan. Creative Ventures, LLC sued JWA and its investors for breach of contract, usury, fraud and negligent misrepresentation.  The trial court found that JWA and its officers knew it was unlicensed by October 1, 2003, before plaintiff’s loan and therefore that JWA was liable for fraud and negligent misrepresentation.  The loan was usurious but the court did not whack JWA for treble damages since the court concluded that there was reasonable error by JWA, due to a mistake.  The judgment against JWA was for all the interest and loan fees the borrower had paid in connection with its loan.

As for the private money investors who had supplied the funds for the $2M loan, the Court concluded the lenders were “holders in due course” and so the plaintiffs lost on their claims against the 50+ individual investors.

That means that the investors, as prevailing parties, won their attorneys fees against the borrower.  The case went to appeal and reversed for the reasons below.

The Appeal

What is a “holder in due course”? Under the Commercial Code, it is someone who takes the instrument (in this case, a promissory note) for value, in good faith and without notice of defenses or a claim of recoupment.

This would have been an absolute defense for the investors if JWA had actually indorsed the note to the investors.  Yes, that was yet another screw up.  The first being that JWA neglected to make it sure it was properly licensed as a broker, the second was that once JWA had originated the loan, it failed to properly transfer the Note to the actual lenders.

The Appellate Court also discussed the distinction between being assignees versus being holders in due course.  The example being that the Commercial Code allows the Promissory Note to be negotiated like a check, that it can be properly indorsed to another party and that physical possession of the Note is transferred to the recipient, thereby affording it all the protections of a holder in due course.  However, an assignment merely has the new assignee stepping into the shoes of the assignor and therefore the borrower would retain whatever claims it had against the assignor as against the assignee as well.

The investors argued that they did indeed have possession of the Note because JWA held the Note as their agent, that by such constructive possession, the element of being a physical holder of the Note was satisfied.  However, the Appellate noted that these investors held only fractionalized interests in the Note and therefore could not be holders in due course.  More disturbingly, the Court concluded that as fractionalized investors, the investors could not transfer the notes to someone else nor could any individual investor sue on the notes in his or her own name.

Instead, the Appellate Court concluded the JWA investors were assignees rather than holders in due course so the borrower retained the right to make claims against them.

Even worse, under the servicing agreement the JWA investors only received 10% interest payments, rather than the 12% in the Note, as JWA retained the spread for its servicing fee.  However, the investors retained full liability for the entire amount of interest payments paid by the borrower.


The judgment against JWA was reversed on the fraud and negligent misrepresentation causes of action.  The investors were liable for usury.  The Appellate Court did not find an error on the part of the trial court for declining to award treble damages and since the investors had lost, and JWA had won, everybody had the opportunity to bring attorney fee motions again.

Author’s Comment

This case bears close reading for a number of reasons.  The first being the brief discussion on the transfer of the Note obligation and what rights the fractionalized investors held in that scenario.  In the private lending community, the odds of the mortgage broker/loan originator and the servicer knowing how to properly negotiate and indorse the loan instruments are low and the Commercial Code is rather vague on handling fractionalized notes in particular.  Furthermore, this case makes it clear that the “intent” of the investors is really irrelevant as to whether or not a Note is usurious—this makes it tantamount to a strict liability finding, with the only discretion being whether treble damages are awarded. [Creative Ventures, LLC v. Jim Ward & Associates, et al. (Sixth Appellate District, filed May 31, 2011).]

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