QUESTION
One of our investors kicked a loan back to us because, supposedly, the loan was a business purpose, not an owner-occupied residential loan. We protested but to no avail. Now we’re stuck with a business purpose loan.
As a small lender, we now have to find a buyer and probably take a haircut. This was a retail transaction, and we did everything right – at least, that’s our view!
We want some guardrails for determining what is and is not a business purpose loan.
Many of the guidelines we already know. However, we’re looking for a deeper set of guardrails.
What special guidelines can be used to identify a business purpose loan?
ANSWER
The guidelines you provided are relatively standard fare. I won’t go here into the ones you mentioned. I will give you five factors that a court used to identify a business purpose loan. Are they comprehensive? Certainly not. However, to use your terminology, these five factors should be considered “guardrails.”
The U.S. District Court for the Central District of California recently granted summary judgment for the defendant, Joel Sherman Levine (“Levine Trustee”), the trustee of the Joel Sherman Levine Revocable Trust (“Levine Trust”), in a case asserting violations of the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA). The court found that the loan to the Ross Trust was a business purpose loan.[i]
Maxine Gilliam (“Ross Trustee”), the plaintiff, had approached a loan broker to procure a lender for a $150,000 loan to be secured by the property owned by the Lou Easter Ross Trust (“Ross Trust”), of which she was the successor trustee.
So, starting us off, we shall observe the war between the Ross Trust against the Levine Trust.[ii]
Please stick with me because, like all wars, it can get complicated!
The broker emailed the Levine Trustee and invited him to fund the loan. The broker and the Levine Trustee exchanged a series of emails in which the broker indicated that
“[t]he subject property has a tenant in place paying $2,000 monthly,” and the Ross Trustee would be “using the funds to invest in a small rental.”
The broker attached an unsigned loan application which stated that:
· The property was an “investment” property, and the purpose of the refinance loan was “business”;
· Ross Trustee was a “Real Estate Investor (retired teacher)”; and
· Ross Trustee owned three pieces of real property.
In connection with the loan, the Ross Trustee signed, among other documents, an occupancy and financial status affidavit certifying that the property was an “investment property.”
The loan had a two-year term with the option for a one-year extension and a balloon payment.
The Levine Trustee subsequently received a letter from an attorney for the beneficiary of the Ross Trust, La Randa Ross (“Ross Beneficiary”), claiming that she resided at the property and had not authorized the Ross Trustee to enter into the loan. Prior to funding the loan, the Levine Trustee didn’t know that the Ross Beneficiary resided at the property.
Although the Ross Trustee maintained that she sought the loan “to make necessary repairs” to the property, she did not provide evidence that she told the broker that the Ross Beneficiary was the tenant living at the property or that the broker or Ross Trustee informed the Levine Trustee of this fact before the parties entered into the loan. After receiving the letter from Ross Beneficiary’s attorney, the Levine Trustee asked for the return of the loan funds and to unwind the loan transaction, but the Ross Trustee refused. The Levine Trust continued to receive loan payments until the end of the two-year term.
At that point, the Levine Trustee declined to grant an optional one-year loan extension.
After the Ross Trustee failed to make the final loan payment, including the balloon payment, the Levine Trustee recorded a notice of default and an election to sell the property under the deed of trust.
This is where the legal gears started cranking because the Ross Trustee then sent the Levine Trustee a notice of rescission of the loan. The Levine Trustee did not respond to the notice, so the Ross Trustee filed an action against the Levine Trustee, alleging violations of TILA and RESPA. The Levine Trustee later filed a motion for summary judgment.
Now, before outlining the five factors for identifying a business purpose loan, let’s recognized that TILA only applies to “consumer credit transactions,” which are loans issued to a natural person and primarily for personal, family, or household purposes. Similarly, RESPA does not apply to credit transactions involving extensions of credit primarily for business purposes.
The five factors – or, if you will, the five-factor test – the court used were meant to determine whether a loan was obtained primarily for business or personal purposes. And I suggest you include these factors in your “guardrail” analysis.
Five Factors to Identify a Business Purpose Loan
Factor 1
“The relationship of the borrower’s primary occupation to the acquisition.”
The court found that the Levine Trustee relied on the statement in the loan application, even though it was completed by the broker, and that the Ross Trustee was a real estate investor, suggesting that the loan was for business purposes.
Factor 2
“The degree to which the borrower will personally manage the acquisition.”
The court found that there was evidence that the Ross Trustee was managing the loan on behalf of the Ross Trust, and there was a lack of evidence as to how the loan proceeds were actually used, which leaned toward a business purpose.
Factor 3“The ratio of income from the acquisition to the borrower’s total income.
It was neutral, but for:
Factor 4
“The size of the transaction.”
The court found that the relatively small dollar amount borrowed leaned toward a personal purpose.
Factor 5
“The borrower’s statement of purpose for the loan.”
However, the court found that, based on the statements by the Ross Trustee and the broker that:
·
The
loan was needed “to make necessary repairs”;
·
The
loan’s purpose was “to invest in a small rental”;
·
The
property had a tenant making rent payments; and
· The property was an investment property, the loan being used for business purposes.
Thus, the court determined that TILA and RESPA did not apply and granted summary judgment for the Levine Trust.
Chairman & Managing Director
[i] Gilliam v. Levine, 2021 U.S. Dist.
(C.D. Cal. 2021)
[ii] Petition denied by, Stay denied by, As
moot Gilliam v. United States Dist. Court for the Cent. Dist. of Cal. (In re
Gilliam), 2022 U.S. App. (9th Cir. Cal., Jan. 3, 2022)
