California Licensing Requirements for Unregulated Lenders and Intermediaries

• Publication year: 2015
• Author: Michael J. Zerman

California Licensing Requirements for Unregulated Lenders and Intermediaries

Michael J. Zerman

Michael Zerman is a Partner at Zuber Lawler & Del Duca LLP in Los Angeles. His practice concentrates on real estate lending, leasing, and purchase and sale transactions for public and private companies, financial institutions, pension funds, and government entities.

I. Introduction

For much of the last century, real estate lenders were most often regulated financial institutions, such as commercial banks, savings and loan associations, and insurance companies, or regulated pension funds, which held exempt status under California's lender and broker licensing laws. Intermediaries, who introduced borrowers to lenders and helped to negotiate the loan terms, were called brokers, and they understood that real estate licenses were required to conduct their trade. Today the roles assigned to those engaged in real estate lending contain many grey areas. For example, private lenders and crowdfunding enterprises frequently create a new entity in order to lend funds on a transaction or a pool of transactions, and then create another entity to receive an origination fee or to service the loan(s).

II. The California Finance Lenders Law

The California Finance Lenders Law¹ governs lenders and brokers engaged in the business of making or negotiating "consumer loans" or "commercial loans." Consumer loans are defined to include most loans where the borrower uses the proceeds for personal, family, or household purposes.² Commercial loans are defined to include most loans for amounts greater than $5,000, whether secured or unsecured, where the borrower does not use the proceeds for personal, family, or household purposes.³ No person may participate as a lender or broker of consumer loans or commercial loans in California without obtaining a license from the California Commissioner of Business Oversight.⁴ Out-of-state lenders that make loans to California residents must be licensed in California as finance lenders.⁵ The process to obtain a license can take between six to twelve months or longer. Anyone who willfully violates the Finance Lenders Law may face fines of up to $10,000 and/or imprisonment for a one-year term.⁶

A. Exemptions

The California Finance Lenders Law provides that certain entities, persons, and transactions are exempt from the general licensing requirements. Exempt categories include:

1. banks, savings and loan associations, credit unions, certain SBA-approved lenders, and pawnbrokers regulated by the laws of any state or by federal law;⁷
2. licensed check cashers;⁸
3. colleges and universities making student loans;⁹
4. securities broker-dealers licensed under California law;¹⁰
5. persons or entities who make no more than five (5) commercial loans in a twelve-month period, and the loans are "incidental" to the primary business of the person relying on the exemption;¹¹
6. certain public entities (including municipal corporations and government agencies);¹²
7. agricultural cooperatives;¹³
8. certain credit card issuers;¹⁴
9. loans made or arranged by California-licensed real estate brokers and secured by a lien on real property;¹⁵
10. cemetery brokers;¹⁶
11. licensed "residential mortgage lenders;"¹⁷
12. commercial bridge loans made by a venture capital company to an operating company;¹⁸
13. franchise loans made by a franchisor to a franchisee;¹⁹ and
14. certain commercial loans and other investments made by certain tax-exempt organizations.²⁰

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B. Limitations of Exemptions

Many lenders do not fit neatly into any of the foregoing exempt categories. For example, an investment banking firm may be an exempt securities dealer under the Finance Lenders Law, but the applicable exemption would not extend to a single-purpose entity that the investment bank forms to fund one or more specific loans. A crowdfunding enterprise could claim an exemption if it does not make more than five commercial loans in a twelve-month period, but only if its lending activities are incidental to its primary business. Therefore, its primary business cannot be real estate lending. Furthermore, this exemption probably would not apply if such loans were funded by a single-purpose entity that has no other primary business.

In the absence of any exemptions, unlicensed entities or persons risk being fined and/or imprisoned for non-compliance with the Finance Lenders Law. When faced with this dilemma, many lenders first seek to obtain a license under either the Finance Lenders Law or the California Real Estate Regulations (as discussed in Section III), because each statute contains an exemption for licensees under the other statute.

C. Application Requirements

The application fee for a California Finance Lender's license is a total of $300, which is non-refundable.²¹ The applicant must file an application with the Department of Business Oversight, which contains responses to eleven multi-part questions and thirteen exhibits with information about the applicant,²² including financial statements prepared according to generally accepted accounting principles that demonstrate a net worth in excess of $25,000.²³ The application's "Execution Section" requires applicants to make thirty-three declarations about the applicant's business operations under penalty of perjury.²⁴ After an application is submitted, the Commissioner of Business Oversight investigates the applicant's principal officers, directors, and any persons who own or control more than ten percent of the applicant, to determine whether any of them have committed a crime or fraudulent act within the past ten years.²⁵ If an entity owns or controls more than ten percent of the applicant, then additional questionnaires and fingerprints must be submitted for each officer, director, general partner, or managing member of the owning or controlling entity.²⁶ However, the Commissioner of Business Oversight may waive this requirement if the Department determines that further investigation is not necessary for public protection.²⁷

Applicants must file a $25,000 surety bond with the Commissioner of Business Oversight together with the other application materials.²⁸ This surety bond must be maintained at all times after the license is issued.²⁹ Licensees that operate from more than one business location must apply for an additional branch office license for each location,³⁰ but only one surety bond is required for all locations.³¹

Licensees must preserve their books, accounts, and records for at least three years for inspection by the Commissioner of Business Oversight.³² Any licensee located outside of California must also agree to make its books, accounts, papers, records, and files available to the Commissioner of Business Oversight at a designated location in California within ten days after any request by the Commissioner, or to pay the reasonable travel expenses, meals, and lodging incurred by the Commissioner or its representatives during any investigation or examination made at the licensee's location outside of California.³³ Licensees are also subject to certain restrictions on advertising,³⁴ and all advertisements (whether printed or oral) must include the license under which the loan would be made or arranged.³⁵

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Once approved, a finance lender's license remains in effect indefinitely until it is surrendered, revoked, or suspended.³⁶

D. Limitations on Licensees

Holding a finance lender's license may not accomplish all of the objectives that the licensee intended. A finance lender's license only allows a lender to make consumer or commercial loans, or a broker to negotiate and perform other broker services in connection with loans made by other finance...