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Lean Startup Legal for the RECF Industry: Part 1

Recently, crowdfunding thought leader Anthony Zeoli published a thought-provoking piece entitled “Why You May Want to Reconsider How “Secure” You Feel About Your Real Estate Crowdfunding Investment.” Patch of Land sincerely appreciates the learned issues that Zeoli points out in his article; this three-part series provided by Patch of Land's Amy Wan intends to respond to his points, provide clarification on the nature of Patch of Land’s current and future offerings; and call for greater collaboration amongst the RECF platforms and its surrounding community for more feedback and suggestions. If the RECF industry--not just portals, but investors, borrowers, advisors, ancillary service companies, and leading law firms in the space--works together, we can collectively influence and manage its evolution.

 

As General Counsel of Patch of Land, I can speak to our company’s dedication to transparency, customer service, and compliance. To that end, I encourage potential and current investors to read our FAQs (a newer, more comprehensive version to be published within days); recent 3-part blog series on scaling, underwriting, and default scenarios; and our Q&A articles.

 

With regard to compliance, the challenge with the RECF industry—and any startup in a novel yet highly regulated space—is that fine balancing act between compliance, cost, and clarity. For companies that strive to be as compliant as possible—or even overly compliant—it’s all too easy to rack up significant legal bills to research how regulations written prior to the existence of your industry might apply. Unfortunately, most RECF startups don’t have an unlimited legal budget. Even those platforms who have raised a significant amount through Series A funding know that just one legal project can cost upwards of a million dollars, and may easily become obsolete by a regulator’s issuing of just one paper on guidance.

 

With that in mind, Patch of Land wishes to see the RECF community grow and flourish. Zeoli has done the community a service by publicly raising awareness around weaknesses that platforms should rectify; the RECF industry must welcome and encourage crowdsourced concerns to push the industry as a whole to work towards greater transparency and to build the foundations upon which the industry will flourish.

 

Having said that, we’d like our informed investors to have greater clarity as to the nature of our notes, as well as our future plans to further protect their investments.

 

Patch of Land Offerings v 1.0

Patch of Land lets our investors know that currently its notes are not guaranteed through our Private Placement Memorandum. Investors risk the loss of their entire investment, and are indirectly collateralized via the underlying loan to a borrower. It works like this: Patch of Land receives a high number of loan applications and, after undergoing a robust and thorough underwriting and due diligence process, funds the best applications with its own internal revolving line of credit—a process we commonly describe as “prefunding.” This means that we must believe in a deal enough to put our own skin in the game. Each of these borrower loans is secured by a first lien position on the rehabilitation property, personal guarantees of one or more individuals if possible, and—going forward—other creative mechanisms that ensure the security of this underlying loan.

 

Patch of Land then publishes the rehabilitation project on its website and issues Borrower Payment Dependent Notes (“BPDNs”) to investors similar to the notes Lending Club and Prosper issue. BPDNs are simply this: investors gets paid when Patch of Land gets paid.  These notes are unsecured, fully amortized credit obligations by Patch of Land to each of the investors of the project. They are not directly collateralized, thus the success of the investment is wholly dependent on the success of the borrower. Therefore, Patch of Land’s duty to pay arises only when the borrower makes payments on the note, which, generally, is done in equal monthly installments and a final balloon payment. A borrower may, however, elect to prepay the loan at no penalty. Investors should be aware that because they are not receiving a secured interest in the property, if the borrower defaults on the loan the investor has no recourse against Patch of Land or the borrower. Patch of Land, however, has a fiduciary duty to take actions to collect money and pay it to investors. Further, Patch of Land has a continued business interest in protecting its own credibility and track record.

 

To be clear, investors’ names are not directly on the corresponding property title.

Patch of Land, in effect, serves as the administrator on each investment, providing clear, effective and unified direction for all issues that may arise regarding the investment property. As so to not overwhelm borrowers with phone calls by numerous investors, Patch of Land currently retains the sole right to recourse in order to best protect investor funds.

 

As Zeoli explains in his article, sometimes an individual developer will personally guarantee the underlying project loan. To be clear, this does not mean that an investment is “guaranteed.” Instead, a personal guarantee is a legal document in which an individual becomes a guarantor of the loan. The personal guarantee is indirectly—not directly—tied to the corresponding BPDNs that are issued to investors. When able, Patch of Land requires personal guarantees to enable multiple avenues to collect on a debt in which the foreclosure or resale of the collateral does not satisfy the debt. In some states, lenders may concurrently go after the personal guarantee and foreclosure, whereas in other states, a lender can only go after the personal guarantee after a foreclosure.

 

One question we are frequently asked is what happens in the unlikely event of Patch of Land’s failure. Patch of Land has contracted with and transferred over our loan servicing functions to one of the largest national loan servicers that manages over $3 billion in loans. Loan servicing is the process by which a company collects interest, principal and escrow payments from a borrower. In the unlikely event that Patch of Land were to declare bankruptcy, this vendor would continue servicing these loans and would take on the additional responsibility of making disbursements directly to investors based on their pro rata share of the company.

 

Documentation of Collateral

Patch of Land is committed to transparency as much as it is committed to privacy rights and compliance. Early on, our founders decided not to publish notes (or rather, the loan documents) openly on our platform because we had no scalable way to redact sensitive personal information, such as the guarantor’s social security number, residential address, and banking information. As our business has grown, the decision over whether to publish the underlying loan documents is one that has been increasingly discussed. Patch of Land is currently considering the publication of draft loan documents, which seems to be a middle ground between transparency to investors and privacy of our borrowers and guarantors.

 

Additionally, in keeping with Patch of Land’s philosophy of working hyperlocally, we work with outside counsel in each state to draft our loan closing documents--even in those states that do not require an attorney for closing. In that process, we conduct an extensive interview and vetting process to ensure that the attorney has extensive experience in handling our specific type of transaction. We require that our outside counsel be members of their respective State Bar and carry legal malpractice insurance.

 

On the topic of balancing privacy with transparency, Patch of Land does not publish a personal guarantor’s FICO credit score on our website. Although we do perform exhaustive background and due diligence research on each borrower and guarantor and do review a guarantor’s credit score and history, federal laws such as the Fair Credit Reporting Act and Gramm-Leach-Bliley Act indicate that open publication of this sensitive personal financial information may not be permissible. We continue to work with outside counsel to research ways to provide optimal transparency while protecting the privacy of our borrowers.

 

We (and Third Party Appraisers) Watch Over The Borrower

Patch of Land works to fully protect investor funds through various methods of control and oversight. For every project, we commission an independent third party full walk-through appraisal by a certified licensed appraiser familiar with the local market. Each appraisal report contains an “As Is” and a “Subject To” value in order to provide Patch of Land and its investors with the most accurate property values. On large renovation projects where a disbursement schedule is needed, we may commission the appraiser or other independent third party to do a field inspection confirming work completed before each disbursement. In addition, a title run down is performed prior to each disbursement of funds. The developer requirements are unique to each property and can be found in the specific property’s write up on the portal. As part of our commitment to transparency, we post project updates and photos as work is completed in order to give our investors the most up-to-date information and progress about the property underlying their loan.

We hope this helped clear the air about how our real estate crowdfunding platform operates. If you're still uncertain or have any questions, please leave us a comment below.  In the meantime, stay tuned for Part 2 of this 3-Part series when Amy discusses risk factors and how Patch of Land looks to counteract them before they arise.

Still uncertain?  Have any questions?  Leave us a comment and let us know what you think!



If you want to learn more, take a look at some of the most commonly asked questions we receive about real estate crowdfunding on a daily basis and find out why so many people are crowdfunding real estate projects across the country with Patch of Land.
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If you still want to know how Patch of Land works for professional real estate developers and accredited investors, please visit Patch of Land’s FAQ section and learn more today.

2 thoughts on “Lean Startup Legal for the RECF Industry: Part 1”

  • Gabriel Kahan

    Gabriel Kahan commented September 16, 2014

    Is Patch of Land working on a system that updates the borrower on how the property is moving along. It would be great to get periodic updates on how the renovation has been going on. Thanks

    AdaPia d'Errico

    AdaPia d'Errico reply September 17, 2014

    Gabriel, thank you for the question. We are indeed working on a system for regular updates. We are in touch with the borrowers to get pictures, even videos when possible, to keep everyone informed on the progress being made. Thanks for your patience while we get this system more fully in place.

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