By Carrie Salls | Mar 3, 2017

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 note.


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 purchaser.


“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.

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