SAN JOSE – The California Court of
Appeals, in a Feb. 16 ruling, held that a promissory note did not qualify as a security under two
legal tests. However, Allen Matkins Leck Gamble Mallory & Natsis LLP
partner Keith Paul Bishop said the ruling in People v. Black “is limited to the
particular facts presented.”
“Businesses should continue to be alert to the possibility
that they may be subject to California’s securities law when issuing promissory
notes,” Bishop told the Northern
California Record. “They may, however, take some comfort in the fact that
this court wasn’t willing to read the statute defining a security literally.”
In fact, Bishop said, this issue may not even be on the
radar of other businesses.
“Many businesses that borrow money may not realize that
their promissory notes might to subject to the securities laws,” he said.
In People v. Charles Baxter Black, the defendant was charged
with violating Corporations Code Section 25401, which prohibits the making of
false statements as part of an offer to sell securities, after he had convinced acquaintance
Bronic Knarr to invest in Idaho real estate in exchange for a promissory
According to the appeals court opinion, the promissory note
was “amended and extended several times but never realized.”
The appeals court ruled that the promissory
note issued by the defendant and related amendments were not securities as
defined by the California Supreme Court’s risk factor test or the U.S. Supreme
Court’s investment contract test.
Specifically, the California appeals court ruled the
promissory notes offered by the defendant were not made as part of an
“indiscriminate offering to the public at large where the persons solicited are
at random,” according to a piece written by Bishop for the National Law Review.
Specifically, Bishop wrote that the defendant already knew
the person who bought the promissory note, and that person was the only
“However, the Court of Appeal also found that the promissory
notes represented individually negotiated, one-on-one transactions with the
defendant,” according to Bishop’s National Law Review article on the case. “In
this respect, the promissory notes resembled the agreement between family
members that the U.S. Supreme Court found not to be a security.”
According to Bishop, the appeals court ruling does not
specify exactly which transactions do not qualify as securities, at least in
part because the finding was limited to the case at hand.
“The court did not establish any bright line test for
distinguishing between a note that is a security and a note that isn’t,” Bishop
said. “This leaves open the questions of how individualized a transaction must
be to avoid the application of California’s securities laws.”
The state of California filed an appeal after the trial
court dismissed two of the five counts against Black of using false statements
in the offer or sale of a security based on a ruling that the promissory note
in question does not constitute a security.
Bishop said he agrees with the appeals court ruling.