Facts: A broker arranged a mortgage loan for a borrower which was funded by a lender, an entity solely owned by the broker. The broker did not receive a broker fee on the transaction. The note evidencing the loan carried an agreed-to interest rate exceeding the usury limitations. The borrower defaulted on the loan and the lender foreclosed on the property.

Claim:  The borrower sought to void the foreclosure sale, claiming the interest rate on the loan violated usury limitations since the broker was not paid a broker fee by either party for arranging the loan.

Counter claim:  The broker claimed the loan was exempt from usury interest rate limitations and the foreclosure sale was valid since the broker received compensation for arranging the loan as the owner of the lender.

Holding: A California Court of Appeals held the loan was exempt from usury limitations and thus the mortgage foreclosure sale was valid since the broker received compensation as the owner of the lender. [Bock v. California Capital Loans (2013) ___ CA4th___]

Usury: know your limits (and the law)

If a broker makes or arranges a mortgage, usury laws do not apply. Today, the primary goal of usury laws is the prevention of predatory lending practices by unlicensed and unrepresented private lenders.

Predatory lending involves charging interest at unreasonably high rates (read: a rate that is exorbitant).

Today, any non-exempt loan with an interest rate exceeding the threshold set by law is categorized as usurious, without regard for rates of inflation, risks or market conditions. [Calif. Civil Code §1916-3(b)]

California’s usury law limits the interest rate on non-exempt real estate loans to the greater of:

  • 10%; or
  • the discount rate charged by the Federal Reserve Bank of San Francisco, plus 5%. [Calif. Constitution, Article XV]

Related reading

Ch. 41 of Real Estate Finance: Usury and the private lender

During the Great Depression, California legislation exempted certain types of lenders from usury restrictions. The exemptions were implemented with the intent to open up the loan market. [Cal. Const. Art. XV]

These exemptions to usury laws remain in place today and more have been added. For example, in 1979, mortgages made or arranged by brokers in California were exempted from usury restrictions.

Other types of lenders exempted from usury law restrictions include:

  • savings and loan associations (S&Ls);
  • state and national banks;
  • industrial loan companies;
  • credit unions;
  • pawnbrokers;
  • agricultural cooperatives;
  • corporate insurance companies; and
  • personal property brokers. [Cal. Const. Art. XV]

In effect, licensed lenders are today exempt from usury law.

The exempt brokered real estate loans – trust deeds/mortgages – fall into one of two categories:

  • the private lender who made the loan is a licensed real estate broker; or
  • a real estate broker is compensated to arrange the loan as an agent of at least one of the parties to the loan. [Winnett v. Roberts (1986) 179 CA3d 909] (Disclosure: the legal editor of this publication was the attorney of record for the borrower in this reported case.)

But what do these distinctions actually look like?

Acting as an agent

In practice, acting as an agent can be parsed into two requirements:

  1. the broker must negotiate the loan on behalf of a third-party; and
  2.  the broker must receive compensation or arrange the loan in expectation of compensation. [Calif. Civil Code §1916.1]

If a broker is acting as an agent, they are neither the borrower nor the lender. Instead, they are a representative of either party. Thus, they are required to receive compensation for arranging the loan since they are not lending their money and receiving earnings – interest – on the loan.

However, in the Bock case, the lender was solely owned by the broker. Thus, the broker expected to receive compensation through the interest accruing on the loan made and held by the broker-owned entity – portfolio income for him rather than trade or business income.

Nothing in the made-or-arranged exemption for brokers requires the compensation received by a real estate broker to be in the form of a direct broker fee for the exemption to apply.

Thus, though indirect as passed through from a controlled entity, the broker received compensation as the stockholder of the entity which was the lender, satisfying this requirement. [Stickel v. Harris, 196 CA3d 575]

Further, a loan “arranged” needs to be negotiated by a broker on behalf of another (i.e., a third-party lender or the borrower) to be exempt from usury law. Thus, the corporate lender qualifies as “another” – a party distinct from the broker arranging the loan. [Calif. Business and Professions Code § 10131(d)]

Further, the lending entity (read: the lender owned by the broker) is considered a legal entity distinct from the broker. Since the broker negotiating the loan was the sole owner of the lender and the lender was a separate California corporation, the arranging broker qualified as the agent of “another” entity, legally distinct from the broker. [Grosset v. Wenaas (2008) 42 Cal.4th 1100]

Pay to play

If a buyer plans to obtain financing in the form of a brokered loan, they best be prepared to perform on their commitments in the note and trust deed.

Courts rarely invalidate contracts or their provisions which are entered into in good faith between competent persons. If the lender charged an outrageously excessive interest rate or committed fraud on the borrower, playing off of a buyer’s naivety and qualifying as predatory lending, legal remedies are available to protect the borrower.

However, this was far from the issue in the Bock case.

More often than not, cases involving claims of usury are the result of a buyer who bit off more than they can chew. These buyers simply want to escape from enforcement of their agreements and grasp at any legal foothold within reach. But courts abhor usury.  The defense to payment of an agreed rate of interest sets a chaotic precedent, one where mutually agreed to contract provisions can be reneged by one of the parties on a judicially disfavored technicality.

Already, usury is being phased out of the law, as evidenced by the growing collection of broad usury exemptions already in place. It is likely to continue to fade in influence, following the logical path it is already on, until all mortgages are exempt from claims of avoidance of the payment of any interest by the law of usury. However, for the time being, if a buyer signs on the dotted line agreeing to a loan arranged by a broker, the buyer cannot exit from the obligation by claims of usurious interest rates.

Usury has more to do with theological concepts dating back prior to Renaissance Italy than with the secular lending practices of today. Usury is a restatement of theology, which has no place in secular lending fundamentals.

In continuing with the separation of church and state and stripping of usury’s reach, expect to see fewer borrowers like the one above getting off the interest enforcement hook on claims the mortgage is usurious.