Hello everybody. In several previous articles I authored for AOA members over the years I discussed the concept of “usury.” Usury can be informally defined as charging a rate of interest on a loan that is greater than applicable law allows.
My column this month will address the California Supreme Court’s ruling on August 13, 2018 (De La Torre vs. CashCall) which held that even if the interest on a loan is not usurious per se, it might still be voidable if the rate is “unconscionable.” But first, let’s review the nature of usurious interest on a loan.
As stated, if the interest rate on a loan is higher than the law permits, then the rate is deemed to be usurious. Usually the maximum rate is a fixed amount, such as 10% per annum on the unpaid principal.
But sometimes the maximum amount is a percentage that must be calculated, such as “the higher of 10% per annum or 5% per annum plus the Federal Bank of San Francisco’s discount rate prevailing on the 25th day of the month preceding either the date of executing the loan contract, or the date the loan is made, whichever is earlier.” (That formula is typically used for loans in which the proceeds will be used for other than personal, family or household purposes.)
Some types of loans have no applicable usurious rate of interest. For example, loans made by banks, certain credit unions and certain types of industrial loan companies are exempt from the usury laws.
Similarly, loans made by a real estate broker which are secured in whole or in part by a lien on real property are not subject to any specified maximum interest rate. Likewise, loans arranged by a real estate broker and secured by a deed of trust on real property are exempt from usury laws.
However, loans made or arranged by a real estate salesperson are not exempt from usury.
The rationale behind exempting loans made or arranged by brokers is that brokers are qualified by the State of California on a basis of education, experience and examination, and their licenses can be revoked or suspended if they perform acts involving dishonesty, fraud or deceit. While a salesperson’s license may also be revoked or suspended for lack of ethical conduct, their education and training are not as great as that of a broker.
What may be surprising to AOA members who are also practicing attorneys is that secured loans arranged (or made) by lawyers are not exempt from the usury limitations. However, if the lawyer is also a licensed real estate broker, then the exemption from usury limitations would be applicable.
Seller carry-back financing from a buyer (i.e., promissory note and deed of trust signed by the purchaser in favor of the seller) is also exempt from the usury limitations. The theory is that the seller never loaned any money to the buyer. It was simply a credit sale.
For a loan of money from a non-exempt lender to a borrower who will use the funds primarily for personal, family, or household purposes, the maximum interest rate permitted by law is 10% per annum. That limitation is contained in Article XV, Section 1, of the California Constitution. Certain lenders, such as banks, industrial loan companies, and other appropriately licensed entities, are exempt from that 10% cap.
For a more complete discussion about the law of usury, please see my article in the July 2017 issue of this magazine.
Based on the new California Supreme Court case (De La Torre v. CashCall referenced above), just because a loan does not impose usurious interest does not mean that the interest rate charged is valid. The rate might be so high that it is unconscionable and, therefore, unenforceable.
For years CashCall had been a lender of consumer loans made to high-risk borrowers. It attracted many borrowers through its numerous television advertisements. One of its signature products was an unsecured $2,600 loan repayable over a 3-1/2 year period at an annual percentage of either 96% or 135%. Persons who took out such loans from CashCall were typically consumers with low credit scores and living under financial stress.
One if its customers filed a class action against CashCall in federal court claiming that the company’s very high interest rates, even if they were not technically usurious, should be held as unenforceable because they were unconscionable.
Being uncertain as to whether California law would invalidate an interest rate that was “unconscionable” even if it were not usurious, the federal court asked the California Supreme Court for clarification of that issue.
CashCall argued to California’s high court that if an interest rate was not capped by law (in other words, it was not usurious), it could not be “unconscionable.”
In formulating its business model to set an interest rate on personal consumer loans, CashCall undoubtedly knew that many of its loans would go into default and never be repaid. In order to conduct its business profitably, a portion of the high interest rate it charged to borrowers who do repay their loans would be used to make up for its losses from those who did not.
In the CashCall decision, the Supreme Court recognized that loans to high-risk borrowers often justify high interest rates. But it also determined that courts have a responsibility to guard against consumer loan provisions containing unduly oppressive terms.
Upon analysis, our Supreme Court held, and so advised the federal court: “An interest rate on a loan is the price of that loan, and it is clear that the price term, like any other term in a contract, may be unconscionable.”
Stated in a slightly different manner, the high court explained: “An interest rate is the price charged for loaning a particular amount of money to a given individual or entity. As with any other price term in an agreement governed by California law, an interest rate may be deemed unconscionable.”
But that was as far as the decision went when it responded to the federal court’s inquiry of whether an interest rate could be held unconscionable even if not per se usurious. the California court did not express an opinion as to how high the CashCall rate could be without being held “unconscionable,” and therefore unenforceable.
Nevertheless, promptly following the Supreme Court’s determination that CashCall’s high interest rate loans might be unconscionable (which would then be a matter for the federal court to later decide), CashCall stopped making personal consumer loans.
Why the Cash Call Case is Important to AOA Members
The Supreme Court’s CashCall decision was based on certain sections of the State’s Financial Code. Those code sections will not apply to typical real estate loans involving apartment buildings.
Still, the decision has broad implications for real estate lenders and borrowers. That is, if the interest rate on such loans is unconscionably high, California courts may annul the rate or modify it so as to make it reasonable. As Civil Code Section 1670.5(2) provides: “If the court… finds…any clause of the contract to have been unconscionable at the time it was made the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.”
Contrast that sanction for an unconscionable loan with the penalty if the interest rate under the loan is not unconscionable but is, instead, just usurious. The penalty to a lender for receiving a usurious amount is not just forfeiting the interest exceeding the legislative or constitutional maximum, but forfeiting all interest paid throughout the duration of the transaction. That was the ruling in Hardwick v. Wilcox, 111 C.A. 5th 975, decided by the California Court of Appeal in 2017. There the appellate court held: “When a loan is usurious, the creditor is entitled to repayment of the principal sum only. He is entitled to no interest whatsoever. … Interest payments that were made at the usurious rate should be credited against the principal balance in any action to collect on the note.”
The bottom line for AOA members is this: (1) never specify a rate of interest in any type of loan which exceeds the maximum allowed by law, and (2) if no maximum is set by law, do not provide for a percentage interest rate that seems extremely high to you. What would be “extremely high?” I cannot say. But if your gut tells you it might be, then seek legal advice from a seasoned attorney who practices in the field, or at the very least, lower the rate.
Dale Alberstone is a prominent litigation and transactional real estate attorney who has specialized in real property law for the past 40+ years. He also serves as a mediator of real estate disputes and is a former arbitrator for the American Arbitration Association. He is also available as an expert witness on real estate and resident manager legal matters.
Mr. Alberstone has been awarded an AV rating from Martindale-Hubbell. An AV rating reflects an attorney who has reached the heights of professional excellence and is recognized for the highest levels of skill and integrity.
The foregoing article was authored in September 2018. It is intended as a general overview of California law and may not apply to the reader’s particular case. Readers are cautioned to consult an advisor of their own selection with respect to any particular situation.
Questions of a general nature are warmly invited. Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 269 S. Beverly Drive, Suite 1670, Beverly Hills, California 90212. Phone:(310) 277-7300.