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California bankruptcy court says a forbearance that modifies the original loan is subject to state usury laws in certain instances
Earlier this year, the United States Bankruptcy Court for the Northern District of California granted in part and denied in part cross-motions for summary judgment in an action concerning “piecemeal exemptions” to California’s usury law. Plaintiffs entered into a loan agreement secured by their residence carrying an interest rate of 11.3 percent and a default interest rate of 17.3 percent (plus late fees) with a then-unlicensed lender. They also signed a promissory note, which stated that should they fail to make a monthly payment within 10 days of the due date they would be assessed a late charge equal to 10 percent of the monthly payment. After plaintiffs struggled to make payments, the parties entered into an extension agreement to supplement and amend the original loan (but not replace it), which slightly lowered the initial interest rate but increased the monthly payments and default interest rate. The extension also included language adding a charge on the final balloon payment that was not part of the original loan. Plaintiffs again began to miss loan payments and sought to refinance the loan with a different lender. A payoff quote provided by the defendant included what was originally called a “prepayment penalty” but was later changed to represent a late charge on the principal balance in line with the extension.
Plaintiffs sued the defendant and related parties in state court, seeking damages and alleging claims related to breach of contract, fraud, and intentional interference. After the court denied plaintiffs’ motion for preliminary injunction, plaintiffs filed an appeal on the same day one of the plaintiffs filed for bankruptcy. The defendant eventually filed a motion for summary judgment on the claims in the amended complaint, whereas plaintiffs sought partial summary judgment on several new claims, including that (i) the extension violated state usury law; (ii) the defendant “demanded an illegal acceleration penalty” from plaintiffs; and (iii) the defendant illegally charged multiple late fees on a single loan payment.
In a case of first impression, the court held that under California law, a loan extension that modifies the original loan, including by extending the maturity date, is considered a forbearance subject to state usury laws because there was no other sale, lease, or other transaction involved. The court noted that the statute “provides a restricted definition of the term ‘arranged’ in relation to a forbearance,” and that it also “painstakingly sets forth the instances in which a forbearance negotiated by a real estate broker would be exempt under usury law: when that broker was previously involved in arranging the original loan and that loan was in connection with a sale, lease, or other transaction, or when that broker had previously arranged for the sale, lease or other transaction for compensation.” The court further stated that “[c]onspicuously absent from those instances is a scenario in which a forbearance is arranged on a simple loan of money secured by real estate, with no other sale, lease, or other transaction involved,” adding that it “cannot create an exemption here to save [the defendant].” In the subject transaction, the real estate broker involved when the original loan was made was not involved in the extension, the court said.
The court also held that the loan forbearance violated California usury laws although the original loan was exempt from usury laws, disagreeing with the defendant’s position that “an originally non-usurious transaction cannot be transformed into a usurious transaction at a later point.” The court pointed out the distinction in this case from others cited by the defendant, stating that the “difference between a non-usurious loan and a loan subject to an exemption is slight but distinct. . . . Once the exemption (no real estate broker involved) ceased to apply, the exemption disappeared, and the transaction became subject to the full consequences of the usury law.” Because the extension’s interest rate and default interest rate both violated state usury law, the defendant is entitled only to the principal balance of the extension minus the amount of usurious interest paid.
Additionally, the court determined that under California law, the liquidated damages provision of the loan extension was separate from the interest charged by the extension, and a late charge on top of a balloon payment under extension was an unenforceable penalty provision instead of a valid provision for liquidated damages. The court also declined to consider punitive or other damages and said it will make a determination in the future as to what the defendant is entitled to by way of reimbursements or costs, as well as any interest accrued and owed after the extension’s maturity date.