By: John Beck, California Attorney at Law

This article answers some of the questions about licensing note brokers in California . It indicates the gray areas that are common in a new industry. Many of the issues have not yet been litigated; so the law is simply not clear. As long as the large institutions will work with non-licensed note sellers we are able to function as note brokers. However, it is important that every one in the industry treat every party to a transaction with the utmost honesty and integrity and that we disclose all material facts to all parties. If we do not, we will be legislated out of existence and there will be no secondary market for seller carry back notes. Everyone will suffer.

In both the April and May 1996 NoteWorthy newsletters, I wrote articles on “Licensing in California.“ These articles stated that there are two different licensing statutes that govern the trust deed investment business in California: One for trust deed investors acting as agents and another for trust deed investors acting as principals. In California, if you are a trust deed investor acting as an agent, then you always need a real estate broker’s license-whether you do one transaction or one thousand! See California Business and Professions Code Section 10131(e).

On the other hand, if you are a trust deed investor acting as a principal, then you may – or may not – be required to have a real estate broker’s license. If you are a California trust deed investor acting as a principal and you acquire “for resale to the public“ or actually “sale to … the public“ eight or more trust deeds during a calendar year, then you must obtain a California real estate broker’s license. Otherwise, you don’t need one. See California Business and Professions Code Section 10131.1


Flipping to the Institutional Secondary Market Currently there is a controversy raging within the California trust deed investment community as to whether a California trust deed investor flipping a trust deed (i.e. buying a trust deed and then immediately reselling that trust deed to another trust deed investor at a profit) under a program similar to Metropolitan Mortgage & Securities Co., Inc.’s so-called “Certification to Investor“ is acting as an agent (as opposed to a principal) and, consequently, must be licensed as a California real estate broker. As pointed out in last month’s newsletter, the Metropolitan “Certification to Investor“ program uses a “simultaneous double escrow“ where Metropolitan does not require the trust deed investor to use any of his or her own money to close the first escrow (i.e. buying the trust deed from the owner) before closing the second escrow (i.e. selling the trust deed to Metropolitan).

As can be readily seen, there are two successive, linked transactions – hence the term “double escrow.“ The escrow for the first transaction closes and, then, immediately thereafter the escrow for the second transaction closes-hence the term “simultaneous“ double escrow. Immediately after the closing of both escrows, Metropolitan pays the original seller-carry back trust deed owner what the trust deed investor contracted to pay that person. And Metropolitan then pays the trust deed investor the difference between what that investor contracted to pay the original seller-carry back trust deed owner and the amount that Metropolitan agreed to pay to trust deed investor for the trust deed. Hence, the trust deed investor is using Metropolitan‘s money – and not his or her own money-to purchase the trust deed from the seller-carryback trust deed owner. The Old Gray Fox As pointed out in last month’s article, Larry A. Alamao, Attorney in Charge, Sacramento Legal Section, California Department of Real Estate (916-227-0789) has taken the position that: “From the description of the note broker program, it does not appear that a person engaged in those acts would, in fact, be buying and selling as a principal. The substance of those transactions, if not the form, is acting in an agency capacity.“ Basically, Mr. Alamao feels that if a trust deed investor buys and then immediately resells a trust deed using a simultaneous double escrow where that investor uses none “his [or her] own money“, then that person is acting as an agent-and, consequently, always must be licensed. California statutory law does not directly address this issue.

Old Gray Fox

However, after contacting Mr. Alamao, he gave me the legal authority he says supports his position: The California appellant court case of Gray v. Fox (1984) 151 Cal.App.3d 482, 198 Cal.Rptr. 720. The facts of this case were the following: In May 1979, Dallas H. Gray III and Susan L. Gray (the Grays) listed their home with Sterpa Realty, with the listing agent being Carol Moulton. The Grays entered into a purchase agreement with a buyer from Ireland to sell their home for $120,000. In June 1979, one Stephen Hobbs (who was a licensed California real estate broker) did an appraisal of the Grays’ home and expressed an interest in buying it if anything were to go wrong with the proposed sale. As the court stated: “The overseas deal did fall through, and Hobbs and Sterpa arranged for a sale of the property to Hobbs, with Hobbs to split the $7,200 commission on the sale with Sterpa. The two page ‘Real Estate Purchase Contract and Receipt for Deposit’ had typed in ‘Seller is aware that Buyer is a licensed real estate broker.’ It also stated that seller has employed Sterpa Realty Register/Steve Hobbs as Broker(s) and agrees to pay for services the sum of 6% of sales price.’ Hobbs signed his name in the space provided following the words ‘Real Estate Broker.’“ During his negotiations with the Grays, Hobbs made a counteroffer which the Grays accepted extending the escrow period to 45 days and changing the escrow company to Interstate Escrow Company. As the court stated: “Escrow instructions number I 25764 A were prepared at the Interstate Escrow Company (Interstate) dated July 9, 1979. These instructions provided that commissions of $3,600 each were to be paid to Sterpa and Hobbs.“ The court went on to state further that: “One day later, July 10, escrow instructions number I 25765 A were drawn up for the same property with the Raffertys as purchasers, price to be $144,000.“

As the court stated: “Hobbs set up a ‘double escrow,’ …“ Hobbs was attempting to buy the Grays’ home for $120,000 and resell it for $144,000 – making a $24,000 profit in addition to a $3,600 real estate brokerage commission. Further the court stated: “Pursuant to the purchase contract, Hobbs was to obtain an 80 percent loan with Contempo Mortgage Corporation (Contempo). The escrow instructions provided that ‘buyer’ was to obtain a new loan on the subject property for at least $96,000. There was no evidence that Hobbs applied for a loan, but the Raffertys applied for a loan with Comtempo two days after their escrow opening on July 13, 1979.“ Further, according to the court: “The Raffertys’ loan application at Contempo contained information that Moulton was the ‘listing office’ on the property and Hobbs was the ‘selling office,’ which property was still owned by the Grays at the time.“ The court stated: “It is clearly within the realm of reasonable inferences that the sale of the Grays’ property to Hobbs was conditioned on Hobbs’ being able to utilize the funds in the Hobbs-Raffertys escrow as money to close the Grays-Hobb escrow. Thus, the entire package was one transaction.“ Hobbs apparently intended to use none of “his own money“ to close his purchase escrow.


What Happened Next? Hobbs was not able to put together his “double escrow“ sale. As the court stated: “Hobbs did not deposit money with the Grays-Hobbs escrow by the end of the 45-day period and the Grays threatened cancellation in September.“ Further: “On or about September 9, the Grays received a letter at their property addressed to the Raffertys. They became concerned that Hobbs might be trying to ‘cheat’ them. Thereafter, Moulton was able to get Hobbs to sign cancellation papers. The Grays were under pressure to make payments related to the property they were purchasing and they accepted a cash offer of $115,000 [for their home].“ On February 6, the Grays sued Hobbs seeking damages equal to the difference between $115,000 (the price the Grays ultimately were forced to sale their home for) and $144,000 (the price Hobbs had agreed to pay for the property). Hobbs did not answer the law suit and the trial court entered a default judgment against him for $5,000 in damages (being, apparently, the difference between the $120,000 price Hobbs contracted to pay for the Grays’ home and the reduced $115,000 price their were able to obtained after Hobbs defaulted on the purchase contract).
The Grays then filed an application with the trial court for recovery of the $5,000 judgment against the Real Estate Education, Research and Recovery Fund under Business and Professions Code Section 10471(a) which provides in part: “When any aggrieved person obtains a final judgment … against any person or persons licensed under this part, under grounds of fraud, misrepresentation, deceit … arising directly out of any transaction when the judgment debtor was licensed and performed acts for which a license is required under this part … , the aggrieved person may, …, file a verified application in the court in which the judgment was entered for an order directing payment out of … [the Fund] …“
The California Department of Real Estate (DRE) filed a response denying the application contending “that Hobbs did not commit fraud, misrepresentation or deceit with respect to the Grays, and that Hobbs was not performing acts in his dealings with them for which a real estate license was required.“ Apparently the DRE felt that Hobbs was acting as a principal – not as an agent. Since the judgment against Hobbs was taken by default, the matter was re-litigated on July 28, 1982. On October 1, 1982, the trial court found against the DRE and ordered payment of the $5,000 from the Fund.


During the trial, the trial court made the following observation which was reproduced in footnote 5 of the appellant court opinion: “If a guy wants to buy a piece of property and go out and tell everybody: ‘I’m buying this piece of property. I don’t expect to make a commission on it. I’m a buyer. I’m an individual. And Mrs. Moulton, you’re the broker for this transaction and you’re going to get your commission. I don’t want any part of it. I just want to made a good deal here for myself. I’m going to buy this house.’ But the whole thing kind of smacks of something a little bid different here. You know, human nature is as it is, and he [Hobbs] saw a chance to get a commission here and make a fast sale there. A lot of big money doing on for him. Had he been successful – what did you say? $26-or-$27,000, or whatever it was – the Grays wouldn’t have known the difference, nobody would have known the difference. But it didn’t come to pass.“ The DRE disagreed with the trial court’s decision and appealed The Appellant Court’s Conclusion The appellant court concluded: “The facts substantiated that the substance of this transaction was to be a sale by the Grays as sellers of their property to the Raffertys as purchasers without their knowledge of the facts, and with real estate broker Hobbs acting as a conduit. Hobbs planned to facilitate the transfer of title for a fee from the Grays to the Raffertys, and it was never his intent to hold title to the property. Hobbs was in effect acting as a broker for the Grays as sellers and the Raffertys as buyers.“ Further: “… [The Grays] were defrauded by Hobbs acting as a licensed real estate broker in the proposed sale of their property, and … they were damaged as a result of his conduct, thus entitling them to a recovery of $5,000 from the Fund.“ What Does the Old Gray Fox Teach Us? Must a trust deed investor availing himself or herself of a program like Metropolitan’s “Certification to Investor“ program be licensed as a real estate broker in the state of California? Mr. Alamao of the DRE says yes. Is his opinion correct?

Fiduciary Duties Complicate Matters

As I stated in last month’s article: “I don’t think so.“ It’s my opinion that both the trial court and the appellant court’s decisions clearly hinged upon the fact that Hobbs’ was trying to play the money-making game both ways: First as a real estate broker making a $3,600 brokerage commission and, second, as an investor making a $24,000 profit. Trying to play the game of being both agent (and receiving a $3,600 commission) and principal (and receiving a $24,000 profit), he severely – and carelessly – blurred the distinction between acting as an agent and acting as a principal. After all, he stated in his purchase agreement with the Grays that he was being “employed“ by them as a real estate agent and was to be paid by them “for [brokerage] services the sum of [one-half of] 6% of sales price“ of the Grays’ home. Was he the Grays’ real estate agent – or not? He stated – in writing – that he was! The trial court and the appellant court agreed with him. As the appellant court stated: “He [Hobbs] deliberately placed himself in a position whereby he assumed the status of broker.“ And: “With broker status comes fiduciary duties, which include the obligation of acting with the utmost good faith and honesty toward the seller, and precludes the broker from assuming a position adverse to the seller without the seller’s consent.“

Clearly the typical unlicensed trust deed investor buying a deed of trust as a principal under a trust deed purchase agreement and, then, reselling that trust deed to an institutional secondary market, seller-carryback buyer under a program like Metropolitan’s “Certification to Investor“ program has not blurred the distinction between acting as an agent and acting as a principal. The carryback trust deed seller clearly understands that the trust deed investor is acting on his or her own behalf (i.e. as a principal) and not on behalf of, or as a representative of, the trust deed seller (i.e. as an agent of the seller). Further, the institutional investor clearly understands that the trust deed investor is acting on his or her own behalf (i.e. as a principal) and not on behalf of, or as a representative of, the institutional investor (i.e. as agent of the institutional investor). In my opinion, the Old Gray Fox clearly does not apply.

If you would like a copy of the Fox v. Gray decision, send a self-address, stamped envelope to John Beck at 1024 Regent Street, Alameda, CA 94501. Licensing in California.

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