Creditor Fails to Navigate Usury Law “Minefield”, Ordered to Refund $1.3 Million to Debtor

A recent court decision demonstrates the complexity and dangers faced by creditors attempting to navigate California’s usury laws. In the case, a lender agreed to purchase a debtor’s promissory note from a bank and refinance it for a lower amount. The entity that the lender used to purchase the note from the bank was a licensed California real estate broker. Simultaneously with the purchase of the note by the first entity, the lender assigned the note to a second entity under its control. Later the debtor defaulted on the note and filed bankruptcy.

In the bankruptcy proceeding, the lender filed a claim against the bankruptcy estate for the remaining amount due on the note. The debtor objected to the claim and argued that the interest rate that had been charged by the lender was usurious. As such, the debtor asked that the court order the lender to refund the usurious interest that had been paid.

While the lender agreed that the rate charged on the note exceeded the maximum rate set by California’s usury law, the lender argued that the purchase of the note had been arranged by a licensed real estate broker and therefore the transaction was exempt from the usury restrictions. After a two day trial, the court found in favor of the debtor and order the lender to refund over $1.3 million to the debtor.

In its decision, the court noted that the California legislature had provided an exemption from the applicability of California’s usury laws by exempting “any loan or forbearance made or arranged” by a licensed real estate broker and secured by real estate. The court went on to explain, however, that the exemption only applies where the broker was acting on behalf of another. Where a broker is acting as a principal, the exemption does not apply.

After examining the relevant loan documents, the court found that the purchase of the note by the first entity had been done on its own behalf and not on behalf of the entity to which the note was later assigned. The court rejected the lender’s argument that the lender had done little to formally structure the transaction as a broker-principal arrangement simply because it controlled both entities and knew it would be transferring the note following the purchase from the bank. For that reason, there was no “need to report anything to [itself]”. The court was unpersuaded by this argument and stated that “[t]he usury laws present a minefield that people in the [lender’s] position, with their… status as licensed brokers, can readily navigate. This time they did not navigate carefully.”

In light of this case, lenders doing business in California should be careful to “navigate carefully” the complex usury laws of that state, lest they too become a victim of its “minefield” of statutory dangers.

In re Arce Riverside, LLC, 2015 Bankr. LEXIS 3275 (Bankr. N.D. Cal. Sept. 28, 2015)