Are fractionalized deed of trusts allowed in Washington state?

Question

As I recall WA does not allow fractionalized deed of trusts for real estate, but a friend of mine actually participated in one as a lender on a 4-plex investment in Seattle. The borrowers stopped paying him so he wants to pursue collections actions on the debt/property/borrowers.

Does anyone have any info on this or a link to the WA website which defines if this is now allowed/legal? @Mike Hartzog any thoughts?

Thanks

Does anyone have any info on this or a link to the WA website which defines if this is now allowed/legal? @Mike Hartzog any thoughts?

Thanks

Mike Hartzog · Answer

OK, thanks for the explanation.  That IS a pain.  That's what a business entity is for in the first place, i.e., business entity is the beneficiary on the DOT and it forecloses, assigns, whatever...

Bob Malecki · Answer

Hi @Mike Hartzog a fractionalized Deed of Trust is where there are multiple lenders listed on one deed of trust, rather than having them on separate DOTs and recorded in order of seniority/subordination. So, in the scenario above, my associate now has to file foreclosure, but since there are 4 other beneficiaries listed on the DOT, he has to find them, contact them and have them all agree to foreclose then sign off on authorizing a substitute trustee to start the foreclosure. What a pain in the butt. This is all with local Seattle investors, which you may know.

Mike Hartzog · Answer

@Bob Malecki - Is a fractionalized DOT in this case simply having multiple parties responsible for the repayment of the loan, or is it more along the lines of specific percentages assigned to each party?

Mauricio Rauld · Answer

Got it.  Sorry to heat that.

Bob Malecki · Answer

Thanks @Mauricio Rauld I understand the securities space pretty well and operate a few Reg D funds. My original question had to do with fractionalized deeds of trust in Washington state. A fellow investor loaned monies with 4 others to a company  to purchase some property in Seattle and build a 4-plex, and the sponsor used a fractionalized DOT. Now the company sponsors have gone dark and I just found out that they administratively dissolved the LLC that borrowed the funds a year after doing the loan. Even more, the only DOT on that parcel is a loan from a different investor which they recorded after the former loan.

I advised my associate to get with a good RE attny to start foreclosure and contact WA DFI to register a complaint. I know the sponsors and kind of guessed they worked on the shady side of things.

Mauricio Rauld · Answer

@Bob Galecki Bob, whether a note is a security is one of the grayest areas of security law.  No kidding, but the Courts basically say if a Note acts like a security, it walks like a security, or quake as a security, then it probably is a security.  Whether a note is a security or not has become complex with numerous exemptions, including a private note that is less than 9 month (by definition not a security).  Unfortunately you need to worry about the catch all in that definition which is an investment contract.  So even if you did a note for less than 9 months, if you offered that note to a bunch of people, it will be considered a security.

There are basically 2 exemptions that 95% of Syndicators use; 506B (no advertising but non-accredited investors are welcomed) or 506C (you can advertise but can only accept Accredited Investors). Another exemption is the Intrastate Exemption, where the sponsor, investors, perspective investors and asset are all located in the State.  In that case, we would focus on WA securities laws and you would want to engage a local securities attorney.

Hope this helps and adds value to, my friend.

Regards,

Mauricio

Jay Hinrichs · Answer

@Bob Malecki @Mike Hartzog  same language as Oregon.. and a real estate paper offer or short form securities type document required..  this is why a lot of folks think that partials that are talked about being bought or sold can run into security issues.. And why in my day in Oregon when I was active at this my preference was doing a hypothication.

but having faced the corporate division lawyers personally they are some sharp dudes and well you and your attorney can argue your interpretation of the laws.. The state will have theirs and unless we were prepared to go to law court and spend 100k arguing this.. it was easier to just create the securities offering Oregon wanted us to have.. and that our securities attorney told us we did not need.. that one cost me 30k. and a 5k fine. :)

Bob Malecki · Answer

Ok, here is what I got from WA Dept. of Financial Institutions (DFI). I've highlighted the key language in bold below.

From what I gather, a DOT is compliant with the "whole note" exemption if compliant with the terms described below and is NOT compliant if:

A bond or other evidence of indebtedness is not offered and sold as a unit if the transaction involves:

(a) A partial interest in one or more bonds or other evidences of indebtedness secured by a real or chattel mortgage or deed of trust, or by an agreement for the sale of real estate or chattels;

Soooo, a partial interest as referenced above would disqualify the exemption compliance.

NOTE: I'm not an attorney and not posting legal advice! This is only my interpretation...........

Bob,

In your email, you ask whether there may be multiple lenders on a deed of trust, by which we assume you are asking whether this is consistent with securities laws.  We also assume that the arrangement that you describe involves the issuance of a promissory note (or other evidence of indebtedness) secured by a deed of trust.

The first thing to consider is whether the promissory note is a security.  The Securities Division administers the Securities Act of Washington, which regulates the offer and sale of securities in our state.  “Security” is broadly defined in RCW 21.20.005(17)(a) to include:

any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement; collateral-trust certificate; preorganization certificate or subscription; transferable share; investment contract; investment of money or other consideration in the risk capital of a venture with the expectation of some valuable benefit to the investor where the investor does not receive the right to exercise practical and actual control over the managerial decisions of the venture….(Emphasis added)

Because “notes” are explicitly mentioned in the definition of “security,” courts have held that there is a strong presumption that notes are securities subject to the Securities Act.  Therefore, a person or company that issues a promissory note to a third-party investor may be engaged in the offer and sale of securities.  A person or company conducting an offering of securities needs to be aware that:

• The securities must be either registered or qualify for an exemption at both the state and federal level.
• The individuals and companies involved in the sale of securities must be either licensed or exempt from licensing requirements at both the federal and state level.
• Investors must be given full and accurate disclosure regarding the business.  Material misrepresentations and omissions subject the issuer and the salesperson to liability for securities fraud.

Whether an offering of securities must be registered or qualifies for an exemption from registration depends on the facts and circumstances of the offering.  The various exemptions available at the state level are summarized in our Exemptions Table: https://dfi.wa.gov/securities-registration/securities-exemption-tables.

One exemption that is available in Washington is the “whole note” exemption at RCW 21.20.320(5), which provides an exemption from securities registration requirements for:

Any transaction in a bond or other evidence of indebtedness secured by a real or chattel mortgage or deed of trust, or by an agreement for the sale of real estate or chattels, if the entire mortgage, deed of trust, or agreement, together with all the bonds or other evidences of indebtedness secured thereby, is offered and sold as a unit. A bond or other evidence of indebtedness is not offered and sold as a unit if the transaction involves:

(a) A partial interest in one or more bonds or other evidences of indebtedness secured by a real or chattel mortgage or deed of trust, or by an agreement for the sale of real estate or chattels; or

(b) One of multiple bonds or other evidences of indebtedness secured by one or more real or chattel mortgages or deeds of trust, or agreements for the sale of real estate or chattels, sold to more than one purchaser as part of a single plan of financing; or

(c) A security including an investment contract other than the bond or other evidence of indebtedness.

The key here is that there cannot be any splitting or stacking of interests under this exemption.  By rule, we have further conditioned this exemption as follows:

A bond or other evidence of indebtedness secured by a mortgage, deed of trust or agreement of sale, involves an "investment contract other than the bond or other evidence of indebtedness" within the meaning of RCW 21.20.320 (5)(c) if any of the following services are offered or included by an issuer or its affiliates:

(1) Guarantying the note or contract against loss at any time; or

(2) Guarantying that payments of principal or interest will be paid; or

(3) Assuming any payments necessary to protect the security of the note or contract, excluding necessary advances for taxes and insurance; or

(4) Guarantying a specific yield or return on the note or contract; or

(5) Paying any interest or premium for a period prior to actual purchase and delivery of the note or contract; or

(6) Paying any money other than that collected from the borrower after the note or contract falls into arrears; or

(7) Repurchasing the note or contract, provided that, this is not intended to prohibit good faith repurchases as an effort to assist the investor as long as the representation is not made at the time of sale and not as a part of the sales program; or

(8) Promising the investor a market for the resale of the mortgage paper securities.

See WAC460-44A-075. However, please be aware that even if the “whole note” exemption at RCW 21.20.320(5) is not available, there may be other exemptions that the issuer may rely upon.  For instance, issuers who conduct a private offering may be able to rely upon the exemption at RCW 21.20.320(1), or the exemption under Regulation D, Rule 506(b).  If no exemption applies, the issuer must register the offering of securities.

If you believe that issuers are violating Washington’s laws, you may file a complaint online athttp://www.dfi.wa.gov/consumers/file-complaint/investor-complaint.

Disclosure

Please be aware that regardless of whether an offering of securities is registered or qualifies for an exemption, the issuer must provide the investor with full and accurate information regarding the company.  Material misrepresentations and omissions may subject the issuer and the salesperson to liability for securities fraud.  To get a better idea of the type of information that should be disclosed to investors, you may want to review our brochure on disclosure (http://dfi.wa.gov/sd/disclosure.htm) and Regulation S-K.

Additional Information

For additional information regarding securities regulation, you may find it helpful to review our Raising Capital brochure, which contains general information on raising capital for your business through the sale of securities (available at:http://dfi.wa.gov/sd/raisingcapital.htm).  In addition, you may want to review our Offering Options brochure (available athttp://dfi.wa.gov/sd/options.htm). We have a list of small business frequently asked questions available at: http://dfi.wa.gov/sd/smallbusinessfaq.htm.  The SEC also has a helpful small business guide available on its website athttp://www.sec.gov/info/smallbus/qasbsec.htm.

If you have further questions, please feel free to contact me.

Sincerely,

Jill M. VallelyRegistration Unit, Securities Division

Jay Hinrichs · Answer

Bob I found this on Google its a good read

https://dfi.wa.gov/documents/securities-orders/S-1...

it appears if you have a securities offering you can then fractionalize the notes DTs  this is the same in Oregon were I got my knuckles wrapped by the regulator and ended up having to do just this.. in Oregon they called it a real estate paper offering and you spelled out how your were setting these up and then you had 10 pages of disclosures ( IE how many ways you can lose your money LOL)..

Anyway that's how I read those pleadings..  let me know if you concur

the company that is the subject of this had the securities stuff in place.. they just botched the payoffs.. and of course if you look at the time lines it was deep in the GFC were all of us had issues.. myself included :(  IE borrowers defaulting on us .. and having to chase the collateral.

Mike Hartzog · Answer

@Bob Malecki  not sure about this in WA.  Not something that has come up for me.  Looking forward to learning the answer.  :-)