License required to enter a JV on notes?

Question

Hi all,

Went to an investor's meeting in my town and the organizer invests in performing and non-performing notes. He says the typical length of time in a note is 6-12 months, and sometimes longer if he needs to foreclose, etc.

The plan would be for my wife and I to pay the up front costs (from our 401k self directed) for purchasing, and he does all the work. 50/50 profit split.

We would be entering into a JV agreement.

The big question is: does anyone (myself and/or the LLC we would be entering the JV with) need to have a license of some sort? I've done quite a bit of reading here on BP, and did not reach any firm conclusions.

The LLC owner says he is not selling securities and thus is not required to have a license. My RE attorney said to ask which licenses he has.

Your help and feedback is appreciated. The last thing I want to do is jeopardize the monies in my 401k trust due to trusting when I shouldn't.

Thanks in advance.

Don Konipol · Answer

It may be a great explanation. Unfortunately it is INCORRECT.

The determination of whether the sale of an investment is a security or not has nothing to do with the number of  participants involved.  It is a judgement call in which criteria include active participation, passive participation, purpose, etc.

In any case, since no general solicitation or advertising was done, the deal probably qualifies for exemption from registration under the private offering exemption, or similar such on the state level.

No formal Reg D would be recommended as this is a small transaction.  However, Reg D compliance actually protects the issuer as it is a safe harbor, the issuer utilizing a non safe harbor private placement exemption subjects his offering to interpretation by security regulatory agencies.

All this is of little concern to the passive participant as long as he obtains full disclosure

What is of more concern is the licensing, if any, needed to broker, manage, and service notes.

Purchase of existing notes, whether residentential or commercial requires no license. Modification, servicing, negotiating with the borrower, etc may require licensure IF the note in question is an owner occupied mortgage note.  The big risk in these is being sued for wrongful foreclosure or any of the various violations inherent in the Dodd Frank Act, or regulations promulgated by the Consumer Financial Protection Bureau.

As part of your due diligence, it is imperative to know the active participant's knowledge and experience in these matters.  Further, I am not a fan of the '50/50' split.  There are many methods of figuring the split......priority return before profit split, percentage, bonus, etc.  Most in these small, labor intensive investments work out to 25 to 33% for the labor, 66 to 75% for the capital.

All investments carry an element of risk, NPN carry a moderate to large amount of risk.  If you go into this realize that your investment will be at risk.

Okeoma M. · Answer

Thanks for the shout out @Justin Windham

My two cents:

I agree with @Patrick Desjardins but maybe I'm misunderstanding the nature of the relationship. You should ask him specific questions about why he thinks this doesn't qualify and make  sure he seems EXTREMELY knowledgeable around the rules. Saying "these aren't securities so we don't have to worry about it" doesn't cut it. At the very least you'd need to file the proper exemptions under Reg D.

Also you should talk to a tax professional on the self directed portion because I know that the IRS has been cracking down on creative uses of the self directed 401K funds esp for investors who are at or near retirement.

* While I am an attorney, this is not intended to be legal advice. I would always encourage you to seek out your friendly neighborhood attorney for real legal advice :)

Bob Malecki · Answer

A JV is basically a partnership and no securities license is needed if only between 2 parties. If more than 2 investors are in the deal then usually an exemption should be filed with the local state unless all the investors have created a LLC to take down the deal.

@Carl Henriksen, we do JV's like this with single investors and as long as there is a good partnership agreement executed that cover's all of parameters of the deal then you should be ok. You and the other party can create a LLC or just create a JV partnership agreement and buy the asset in a personal property trust as the entity with you and he/she as the beneficiaries of the trust. Always have a solid written agreement in place.

Bob Malecki

Patrick Desjardins · Answer

Carl,

Just because he says he's not selling securities doesn't mean it's true. Having spoken with a few securities attorney about it, there is no loophole: if you're a passive investor and he's managing the investment, then it's a security.

The only way for it not to be a security is if you have an active role in managing the investment, however limited that role is.

With that said, there are people doing JV deals every day and it's not like the FBI is going to kick down your door and send you to jail. All I'm saying is that based on speaking with those attorneys, these types of JV deals are best done with friends/family who aren't likely to sue you if something goes wrong and you lose money in the deal.

Bob Malecki · Answer

Well, that would depend on the terms set forth in the JV agreement. Ideally there should be dedicated entity created to be the owner of the note on record, and you or your 401K entity should be a member or beneficiary in that entity so that you have recourse on the funds and liquidation of the asset to recover your investment, should things go sideways. That could be a LLC or Trust as previously cited.

If anything, you or your 401K entity should be co-signers on the bank account being specifically used to hold your funds if you don't have a dedicated entity created as owner of the asset with you as a beneficiary or member of that entity.

***Realize that I am not an attorney and not providing legal advice, only reflecting how we have our JV deals set up, based upon the advice from our legal counsel.

Carl Henriksen · Answer

@Okeoma M. Thanks for your feedback. It's amazing how something that seems so simple at the outset is really much more complicated. I'll be checking with my CPA.

@Don Konipol - the gentleman I have been looking at working with DOES purchase owner-occupied (and rental) properties and does do loan modifications. If he were required to have a license, which license would that be? He hires companies to do the servicing.

He seems to be quite familiar with the ins and outs of dealing with note-related landmines in each state that he buys in, but this is clearly a different issue.

Thanks again for everyone's participation in the conversation.

Carl Henriksen · Answer

@Bob Malecki - perhaps you wouldn't mind giving feedback on one more matter. The manager of the fund will be buying the note under his LLC, and ownership %'s and responsibilities are detailed in the JV. All funds are kept in a banking account specifically created for this note. Hoe do you feel about this?

Carl Henriksen · Answer

@Bob Malecki - Thanks for the reply Bob. This is quite helpful - I've looked over the JV agreement, but it's not clear how the notes are owned. So based upon what you have stated, If I'm going to use my 401k solo trust to enter into the agreement with the manager of the note, then this is not an issue. If both my wife and are are going to go in on the same note (along with the manager), then we need an LLC or an exemption filing, correct? Thanks again for your feedback.

Cecilia Arnulphi · Answer

Great explanation Bob.  I was hoping you'd jump in.

License required to enter a JV on notes?

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