Charging Interest Rates Over the Moon!
Ninth Circuit Bankruptcy Appellate Panel (“the BAP”)
In a case of no good deed going unpunished, the Ninth Circuit Bankruptcy Appellate Panel (“the BAP”) recently affirmed the holding of the bankruptcy court in the case of In re Moon that a private money lender’s settlement agreement with its defaulting borrowers violated California’s usury laws by including a provision for interest at a higher rate than that allowed by California law—even though the original loan permissibly charged an even higher rate! The difference, according to the BAP, was that the original loan was made in a transaction involving a licensed broker while the settlement was just between the unlicensed lender and the Borrowers. Had the BAP stopped there, the ruling in Moon would only affect the rare situation where a loan extension was negotiated without a broker involved.
But, the BAP went a step further in its dicta, indicating in a footnote that it agreed with the bankruptcy court’s determination that the involvement of a broker in negotiating or drafting the forbearance would not have mattered because loan extensions/forbearances do not, from a practical standpoint, qualify for the broker exception to California’s Usury Law unless the forbearance is part of a transaction involving the “selling, buying, leasing, exchanging, or negotiating the sale, purchase, lease, or exchange of real property or a business,” which is unlikely to be the case.
The Moons took out a business-purpose loan with an original interest rate of 11.3% per annum. The lender was not licensed as either a broker or a mortgage loan originator; however, the Moons were represented in the original transaction by a licensed broker. Due to the involvement of the Moons’ broker, the original loan qualified for the “broker” exception to California’s usury limit of 10%. Civil Code § 1916.1(1): “For purposes of this section, a loan or forbearance is arranged by a person licensed as a real estate broker when the broker (1) acts for compensation or in expectation of compensation for soliciting, negotiating, or arranging the loan for another, …”.
After falling behind on the loan, the Moons entered into a settlement agreement with the lender which explicitly stated that it was not intended to be a new loan or a forbearance agreement but merely an extension and modification of the existing loan. This agreement lowered the monthly interest to 11.05% but retained the late payment rate of 10%, adding that it was applicable even to the final payment due under the note. This agreement was not negotiated through any broker.
The Moons breached the agreement shortly after entering into it. When they sought to refinance the loan through another lender, they were told that they would have to pay a pre-payment penalty (though the lender later claimed this was an error and was intended to refer to the late fees owed) and, as a result, could not refinance the loan. Angry, the Moons sued the lender in State Court. After the Moons were unable to obtain an injunction, they filed bankruptcy to stop the lender’s foreclosure sale and removed their lawsuit to federal bankruptcy court. The parties brought cross-motions for summary judgment in the bankruptcy adversary action.
Regarding the usury issue, the lender argued that (1) the settlement agreement was not a forbearance; (2) because the original loan involved a broker and was, therefore, exempt from the usury limits, the settlement (if deemed a forbearance) was also exempt; and (3) the settlement (if deemed a forbearance) did, in fact, involve a broker because one of the owners of the lender was a licensed broker. The bankruptcy court sided with the Moons on all three issues. First, the court held that the settlement was, in fact, a forbearance because it extended the Moons’ time for performance and charged a fee for allowing them to do so. Second, the court held that just because the original loan qualified for the broker exemption does not mean that a subsequent forbearance can piggyback off the original exemption. The forbearance must independently qualify for the exemption. Third and last, the court held that Ms. Stuart, the co-owner of the lender, had nothing to do with the negotiation of the forbearance, and therefore, the broker exemption did not apply and the 11.03% interest rate in the forbearance, even though it was lower than what was charged in the original loan, violated the 10% usury cap.
Had the bankruptcy court stopped there, the decision would have the limited effect of only impacting forbearances that were not negotiated or drafted by a broker. But, the bankruptcy court went on to state that it really wouldn’t have mattered if a broker had been involved in the forbearance because:
The statute 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. § 1916.1(2)(B), (3). Conspicuously 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. This court cannot create an exemption here to save Milestone. Moon v. Milestone Fin., LLC (In re Moon), 639 B.R. 190, 198, 2022
Under the court’s logic, a forbearance would generally only qualify for the usury exemption if the same broker that was involved in arranging the original loan was involved and that loan was in connection with a sale, lease or other transaction or that broker had previously arranged the underly sale of the property.1 It is very unlikely that situation would occur or that the broker would be available to now arrange the forbearance. As a result, the bankruptcy court’s ruling essentially restricts the use of the broker usury exemption to any forbearances!
Both parties appealed to the Bankruptcy Appellate Panel. On appeal, the lender abandoned the argument that Ms. Stuart was involved in the forbearance agreement. As a result, the BAP really did not need to get into whether she would have qualified for the broker exemption. Nevertheless, the BAP chose to weigh in on the issue in Footnote 7, where it said that: “As the bankruptcy court emphasized, the Settlement Agreement also did not qualify for the Broker Exemption because it lacked the requisite connection to a past or contemporaneous sale, lease, or exchange of real property.” Milestone Fin., LLC v. Moon (In re Moon), 2023 Bankr. LEXIS 133, *25, 648 B.R. 73
While the BAP’s language is arguably dicta and, therefore, not controlling law and BAP opinions do not have any precedential effect, the bell has been rung and borrower’s attorneys have already started citing the bankruptcy court and BAP’s interpretation in challenges to forbearance agreements.
The case is now on appeal before the 9th Circuit. If the 9th Circuit chooses to weigh in on this issue, it would be binding on other courts. To prevent that from happening, we will be monitoring the appeal and working with the California Mortgage Association to limit the scope of the 9th Circuit’s ruling on the scope of the broker exemption. In addition, we are working with the CMA’s Legislative Committee and lobbyist on a legislative solution.
In the interim, we recommend discussing the usury implications with your counsel prior to entering into any agreement that could be deemed a forbearances where the regular or default interest rate (or the interest rate plus any forbearance fees) will exceed 10%.
T. Robert Finlay, Esq. – Robert Finlay is a founding Partner of WFZ.
Jonathan D. Fink, Esq. – Jonathan Fink is a Partner at WFZ’s California office.