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Borrowing Money? The Legislature May Require You To Tell The DOC

California defines a "security" to include an "evidence of indebtedness" in Section 25019.  Thus, when someone borrows money, they may be offering and selling a security in the form of an "evidence of indebtedness".  I say "may" because "[d]espite their inclusion in the statutory definition, not every note or evidence of indebtedness constitutes a security under the Corporate Securities Law of 1968."  People v. Wind River Mining Project, 219 Cal. App. 3d 1390, 1399 (1980).

For purposes of California's qualification requirement, borrowers in many cases need not engage in a lengthy analysis of whether their evidence of indebtedness is a security because Corporations Code Section 25102(e) exempts "[a]ny offer or sale of any evidence of indebtedness, whether secured or unsecured, and any guarantee thereof, in a transaction not involving any public offering."  The statute refers to "evidences of indebtedness" rather than notes because the Department of Corporations had taken the position that an exemption under prior law for promissory notes did not extend to bonds or debentures. 

Note that Section 25102(e) is only an exemption from the qualification requirements in Section 25110 for issuer transactions.  It is not an exemption from the qualification requirements of Section 25120 or Section 25130.  For example, someone proposing to resell an evidence of indebtedness will need to qualify the resale or identify an exemption from qualification.

Now, two state senators are proposing to amend Section 25102(e) to require the Commissioner of Corporations to adopt a rule that requires the issuer (i.e., borrower) to file a notice of transaction.  SB 978 (Vargas & Price).  An earlier version of this bill would have made this exemption and the limited offering exemption in Section 25102(f) unavailable to those that failed to file timely notices of exemption.  See "Punitive Bill Proposes Giant Step Backwards on Capital Formation".  Fortunately, both provisions no longer withhold the exemption from late filers. 

According to the consultant's report for the Senate Banking and Financial Institutions Committee hearing tomorrow, SB 978 is directed at "hard money lending".  The report defines "hard money lending" as "the lending of money by private  individuals and small pension plans to other private individuals and/or businesses."  The reason given for imposing a notice requirement is "without a filing requirement, DOC has no idea how many persons are operating under 25102(e), nor does it have any knowledge of their identities, nor the purposes for which they are seeking to raise funds."

This bill casts the net far to widely.  The proposed notice requirement isn't limited to just hard money lenders, however they may be defined.  All types of borrowers would be ensnared in this requirement.  Because the determination of whether an "evidence of indebtedness" is a security is far from an exact sciences, some borrowers will be inclined to file prophylactically with the result that even more will become entangled.

According to the committee's consultant, Senators Vargas and Price do not expect to propose any amendments to SB 978 before tomorrow's hearing before Senate Banking and Financial Institutions Committee (which happens to be chaired by Senator Vargas).  However, the bill has also been referred to the Senate Business, Professions and Economic Development Committee (which happens to be chaired by Senator Price).  The consultant reports that the two authors are in discussions with the California Mortgage Association and Department of Corporations and expect to  propose technical and clarifying amendments to the bill before it is heard by the Senate Business, Professions and Economic Development Committee.

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30172DBAB0084D3A8F39D7AF0A8E79BC.ashx Keith Paul Bishop
Partner at Allen Matkins
(949) 353-6328
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