Where Can a Wronged Deed of Trust Investor Sue?
This post was primarily authored by Zachary B. Young, a “Rising Star” for four years running and a Litigation Associate at Patton Sullivan Brodehl LLP.
When any real estate investment deal goes badly and ends in litigation, there are many reasons why a potential plaintiff may prefer one forum versus another, including the location of witnesses and documents, location of attorneys, and state laws. Usually it boils down to convenience — most plaintiffs want to sue in their “home” state.
But a court must have jurisdiction over the parties (personal jurisdiction) and the claims (subject matter jurisdiction) in order to rule on the case. Jurisdiction is an unavoidable gateway for any plaintiff’s case.
In a recent opinion from California’s Second District Court of Appeal — Farina v. SAVWCL III, LLC — the court analyzed whether individual passive deed of trust investors located in California could sue Nevada defendants in California court for a business venture taking place in Nevada. “Where can this suit proceed?” the court asked at the beginning of its opinion, before immediately answering — “The answer is: not in California.”
Facts of Farina v. SAVWCL III, LLC
The Farina case centers around a hard money broker in Las Vegas, Nevada, called Aspen Financial Services, LLC (“Aspen”). By the time of the case, Aspen was bankrupt and was not an actual party to the lawsuit. When it was solvent, Aspen raised money from individual investors and pooled the money into loans for property developers. Aspen’s investors primarily came from Nevada and California, but also included individual investors from other states.
In 2006-2007 (just before the housing market crash), Aspen brokered two loans for West Charleston Lofts III, LLC (“West Charleston”), a Nevada real estate developer. Over 500 individual investors funded the loans, one for $19 million and another for $24 million. The loans were secured by the development project’s real property located in Nevada, and personally guaranteed by various individuals, trusts, and business entities affiliated with West Charleston (collectively “West Charleston Defendants”).
Promissory notes for the loans designated the individual investors as the lenders, but did not disclose their location. Each investor entered a loan servicing agreement with Aspen, which identified Aspen as each investor’s agent for purposes of the loans. All of the money flowed through Aspen, including the original principal amounts from investors to West Charleston, and the repayments from West Charleston to the investors.
As the housing market collapsed, West Charleston defaulted on the loans. In May 2011, the West Charleston Defendants sent a letter to Aspen proposing the investors transform their loans into equity. In gist, the proposed agreement would create a joint venture, whereby the investors would own a portion of the West Charleston development project, in exchange for cancelling the promissory notes, deeds of trust, and personal guarantees. Most investors approved, so Aspen entered into a formal agreement on behalf of the investors, and a joint venture called SAVWCL III, LLC (“SAVWCL”) was created. SAVWCL was created as a Nevada company.
SAVWCL attempted to move forward with the development project and hired a California architectural firm and real estate consulting firm to work on the development. Ultimately, SAVWCL never developed the property and it was sold for a significant loss in January 2016.
A dozen investors, including seven from California, filed suit in Los Angeles County Superior Court. The lawsuit named eight defendants, all Nevada individuals or companies, including the West Charleston Defendants and SAVWCL. The investors alleged broken promises to repay the loans and that they were misled into agreeing to convert their debt receivables into joint venture equity.
Trial court: case dismissed; no personal jurisdiction
At the outset of the case, the defendants moved to quash the lawsuit for lack of personal jurisdiction based on their lack of connections with California. The trial court granted the motion and dismissed the case.
Plaintiffs appealed.
Court of Appeal: affirmed; can’t litigate in California
The Court of Appeal affirmed.
In California courts, “general” personal jurisdiction exists over parties who are “at home” in the state. “Special” personal jurisdiction may exist for an individual or business resident of another state, allowing California courts to adjudicate disputes relating to the defendant’s contact with California.
While other factors can sometimes be involved, in the Farina case the question of jurisdiction turned on whether the defendant group had “purposefully availed itself of a forum’s benefit.” As the court put it: “A defendant purposefully avails itself of a forum’s benefits if it intentionally directs its activities at a forum such that, by virtue of the benefits the defendant has received, it should reasonably expect to be haled in the forum’s courts.”
The plaintiff investors argued that the defendants had purposefully availed themselves of California’s benefits by causing Aspen to contact California investors and by forming ongoing contractual relationships with California investors. Specifically, the investors argued that the defendants used Aspen to induce investors into loans, repayment forbearances, and the joint venture proposal.
The Court of Appeal agreed with the trial court that none of these actions showed purposeful availment. There was no evidence that any of the defendants knew any of the investors were located in California or that Aspen was targeting California investors. Aspen was a Nevada business entity, providing loans to West Charleston for a Nevada project. All of the individuals and entities affiliated with West Charleston were Nevada based. All of the contracts (personal guarantees, loans, grant deeds, and the joint venture agreement) were executed in Nevada and contained Nevada choice of law provisions. Last, the fact that the joint venture, SAVWCL, hired California consulting firms was of no consequence, because those dealings were not at issue.
The court concluded, “you do not purposefully avail yourself of California benefits if you do not know your actions somehow connect to California.”
Lesson
By design, a passive deed of trust investor operates primarily behind the scenes. But that passive role could present jurisdictional problems if the passive investor decides to sue over a deal gone bad. For a California investor who has been wronged, if the party who wronged you has no clue you’re in California, you might not be able to sue in California.
Passive investors may try to preserve a hook for California court jurisdiction by negotiating for certain provisions in the loan documents. While negotiating leverage might not support a “California jurisdiction” or “California choice of law” clause, something less (e.g., a written acknowledgment of the investor’s California residency and source of funds) might provide a starting point for an argument in favor of personal jurisdiction.